Why Uncle Sam must stop subsidizing inefficient companies

From time to time, I'm going to open up this space to guest writers with an interesting point of view. This week, Gregory L. Rosston is taking a turn in the spotlight. Rosston is the deputy director of the Stanford Institute for Economic Policy Research and of the Public Policy program at Stanford University. He served as the deputy chief economist of the Federal Communications Commission from 1994 to 1997.

The Federal Communications Commission is about to continue its anticompetitive policy of protecting incumbent telecommunications providers at the expense of consumers. The FCC has one focus--making consumers better off by forcing suppliers to compete. Yet, nearly every recent FCC decision seems to promote incumbents instead of consumers. Next up is the FCC's proposal to cap universal service funding for new entrants, while maintaining excessive subsidies for incumbent telephone companies.

Ever look at the details on your telephone bill? It shows some, but not nearly all of the money you pay for inefficient "high-cost" subsidies to telephone companies. It's about 10 percent of your bill. That adds up to more than $4 billion per year to subsidize telephone service in certain locations. The costs of this system could grow substantially if Congress or the FCC votes to include more advanced services. The FCC has a chance to revamp the system to inject competition, or even better to eliminate completely the inefficiencies.

Why do we give a $4 billion gift to "rural" incumbent telephone companies? Because they have high costs--even they admit higher costs than their newer competitors. A normal market rewards more efficient providers. But this is the bizarro world of regulation. In this bizarro world, the incumbents are rewarded for their inefficiency. They keep the same subsidies even as they lose customers. Instead of encouraging more efficient competitors and penalizing less efficient competitors, regulators are set to cement in place a system that does the opposite, at the expense of consumers across the country.

High cost "universal service" programs are grossly inefficient because they tax the wrong things and the wrong people, and subsidize many who could easily afford service or who would pay for it themselves. No serious economic analysis shows otherwise.

But rural interests have political power out of proportion to their numbers. That's why taxpayers subsidize rich farm corporations and why urban telephone customers subsidize rural telephone customers, rich and poor alike. Even worse, low-income urban subscribers pay fees to universal service funds that benefit upper- and middle-income residents of suburbs and rural areas. A separate program offers subsidies to low-income consumers, but this program, which at least make distributional sense and is not at issue here, is only a small fraction of size of the high-cost fund.

The FCC has a problem--new entrants are taking customers away from incumbents. Since the new entrant gets a subsidy when it steals a customer but the incumbent never loses a subsidy, competition paradoxically increases the total subsidy.

The obvious solution to this "problem" is to end this mindless pork barrel. At the very least, the FCC should cap the total subsidy and divide the subsidy according to the proportion of rural customers each firm serves. Congressman Joe Barton just introduced a bill to do at least this. Instead of following that logic, the FCC is proposing to cap payments to the successful new entrants, but to maintain fully the payments to the incumbents who are losing customers. The Barton bill actually adds another potentially beneficial step--using "reverse auctions" to drive down the subsidy dollars in each area.

Far better than even the Barton bill would be for Congress and the FCC to declare the high-cost universal service program a success and close it down. The entire program could be capped this year and then phased out over the next five years. A gradual elimination of the program would allow firms to cope with the transition, but it would mean a real transition.

In five years most rural areas are likely to still have service from well-funded rural telephone companies--the cost of continuing to serve a customer is a small fraction of the cost of installing a high-cost telephone line to that customer, and most of those lines were installed years ago. In addition, wireless providers continue to expand their coverage areas, and satellite technology is already making Internet service available anywhere in the country. But these competitive alternatives are less likely to sprout and thrive if they have to compete with an unfairly subsidized provider.

[MadLyb]

Hey Coop. How about allowing a measured rebuttal other than in this lousy Talkback mechanism from a rural consumer of telcom services? While, I have no love for Big Telcos, I think Greg is way offbase in how to deal with this problem.

[ivorycruncher]

No offense, but I don't think the supposed facts behind this problem were properly researched before being presented here. You state that rural telcos have high costs, but you fail to mention why. The keyword here is "rural." Rural phone companies tend to have high costs because they have to maintain equipment and lines and whatnot across a pretty good chunk of territory, and they don't get near the revenue per square mile (or however it's measured) that a company can get in town. A mile's worth of pipeline can bring services to probably at least a couple dozen households or businesses in a city, whereas a mile's worth out in the countryside might service only service 2 or 3 places. Rural access comes at a price, and such a price cannot always be blamed on an inefficient operation. Sometimes the very nature of the business itself is inefficient, and there's really no good way to solve that. Now if there's legitimate proof about rural telcos getting more subsidies than they should, or wasting money, or whatever, then that's one thing. Just don't assume that every government subsidy is bad, without knowing the reasons behind it. I know one thing's for sure. My parents would still be on dial-up out on their farm if it wasn't for those subsidies helping out their local phone company.

[Penguinisto]

Err, why would your parents be stuck on dial-up if it wasn't for rural DSL? Last I checked, there are satellite and long-distance wireless Internet services available. Sure, it has a bit of lag, but unless they're WoW or Unreal Tournament addicts, why would they necessarily have to care about ping times? Now, before anyone shouts, I've done wireless Internet awhile back, over a 33-mile long connection betwixt antennae. the lag time made first-person-shooters just barely tolerable, but usable nonetheless. OTOH, the 1Mb connection did operate just fine for large files, streaming audio/video, and a whole host of normal uses that folks had for Broadband. So, err, before you go crying about how farmers would be in the digital stone-age if it wasn't for some mediocre DSL line from some conglomerate that deigned to stop by and sell it... you may want to look around a bit.

[Gregory_Rosston]

I apologize if I was unclear -- phone companies are high cost for two reasons: serving customers is acutally high cost and companies are inefficient. If competitors can serve customers for a lower cost, which the incumbents claim, then we should not subsidize the inefficient portion. That is the most outrageous part of the FCC's solution to the problem: keep paying high amounts to the inefficient customers. If you want service to rural areas, get it from the most efficient provider. In the end that serves every customer, rural and urban, better. The FCC's plan does the opposite -- it promotes the self-proclaimed less efficient providers.

[saintseminole]

Interesting how this column implies (and in one case says outright) that rural customers are "upper- and middle-income," reaping unfair benefits from poor urban people. In my experience (living in rural areas most of my life), people living in rural areas are MUCH poorer than people living in the suburbs and cities.

That being said, I've never heard of telephone company subsidies. Thanks for bringing it to my attention. This is a travesty. If a business can't survive, it shouldn't. Just like the airlines or farmers (which take in much more subsidies than telecoms, I'm sure).

[Gregory_Rosston]

I agree that there are low income people living in rural areas. But, there are also a fair number of upper and middle income people living there too. It turns out that more than 80% of poor people get absolutely nothing from the rural high cost fund because 80% of poor people live in urban areas. If you care about poor people, subsidize them directly and don't waste money by subsidizing rich rural people. This mechanism is a very inefficient way to get phone service to rural poor people. If you want to subsidize the phone service of poor people, LifeLine and Linkup area a much more direct way to transfer money to the poor.

[RuralPhoneGuy]

Here you go, MadLyb:

Mr. Rosston favors selectively applied economic theory over real-world policy and practice. Since the 1930's the telecom industry has operated under a public policy objective of universal service, providing all Americans comparable access to communications services at comparable rates. In sparsely populated areas it just costs a lot more per customer to provide service. The level of success, though, has reached an essentially steady level of around 95%, a pretty impressive score for any broad public objective. Rural residents can afford reliable telephone service, while urban residents likewise benefit from the ability to call and be called by their rural friends and relatives.

The recent explosion in total universal service support, paid by all telecom customers, has resulted from ill-advised policy supporting redundant wireless service with little or no showing of need for, or public benefit from, the additional dollars. In rural areas wireless service is typically supplemental to, and not a replacement for, existing wireline service. The huge recent increase in support has produced no comparable increase in the availability of reliable and affordable communications service. The simplistic "equal support rule" has assured that wireless carriers, with no demonstrated need, get increased support from consumers based on ? get this ? the costs of the wireline carriers. Talk about inefficient!

Wireless service providers have racked up windfall profits through receipt of "equal support" without equal service requirements or equal public oversight. If we're looking for inefficiencies, let's start with re-examination of this regulatory bias that distorts market competition.

Proposals for "reform" like those advocated by Mr. Rosston amount to regulatory bait & switch. Wireline providers have invested billions locally to meet a public purpose, made possible only through a pubic commitment to a continuing opportunity for cost recovery. Mr. Rosston would just tell them, "We're changing the rules after the game's been played. Sorry about that." The resulting abandonment of facilities, unemployment and default on federal financing obligations are factors that must be weighed against the narrow "efficiencies" he advocates. His "reverse auctions" for future support would guarantee only a race to the bottom, resulting in rural communications services on a level comparable to customer service available from the average wireless company: "Please hold for the next available dial tone."

In fact, no one knows what it would cost for wireless providers in rural areas to meet "carrier of last resort" responsibilities, assuring reliable and affordable service to every customer in the area. Putting existing wireline providers out of business would eventually give us that information, but it isn't likely we'd find that an "efficient" process.

The FCC should first eliminate the unnecessary and unfair "equal support rule," and broaden the base of universal service contribution to require even-handed contribution by all telecommunications technologies that benefit from use of the common network (VoIP, for example, is cheaper because it typically doesn't pay for its use of other carriers' facilities to complete calls.) The result of these two steps would be rapid return to a level of universal service support that was never perceived by customers as a problem, without imposing the risks and penalties inherent in Mr. Rosston's untested "remedies."

[RuralPhoneGuy]

Ivorycruncher: If it wasn't for those support mechanisms your parents wouldn't even have dialup. Or dial tone. Or "Hello, Central, get me Mabel at the drugstore." They wouldn't have service at all.

[MMC Racing]

Everyone always wants a hand out.. Shut down the program.

[gefitz]

Three words: Get in line.

The bill that would limit farm subsidies to those farmers making LESS THAN $1.5 MILLION per year is just about to be vetoed.

I'm moving. I'm tired of carrying the load. At least in other countries everyone is equally gouged by their government.

[vanbrua]

This is one of the best stories I have read form CNET in a long time. It wasn't a press release, it wasn't a rumor about Apple, and it went against what most people think is true. If only the comment system allowed paragraph breaks.

[charlie cooper]

hi madlyb,

drop me a private note at [e-mail] and let's discuss further

[aka_tripleB]

I would like to note that if it weren't for the subsidies for the telephone systems, there would be virtually no competition, and we do know where that lead the last time there was no competition. Besides, those "efficient" telephony systems require broadband connections, which is fine in urban areas where you have a choice of cable or fiber optic connections (you can't have the choice of DSL if you do away with those copper lines). With that requirement for "efficient" phone service, that service is not available for most rural areas. The only broadband that this demographic has for an option is satelite internet. That, however, is not sufficient for "efficient" phone service. The only viable options are traditional phone service and mobile phone service. Given that mobile phone services can range from $0.25 per minute to $99 for unlimited use. It's hard to justify those prices when you look at service areas for states that are "rural." For those of you that live on the east or west coast, lucky you. But some of us, can't justify the price when traditional phone service ranges from $10 to $40 for unlimited local calls and whether or not you want unlimited long distance.

[Gregory_Rosston]

In some rural areas, the subsidy paid to the phone company far exceeds $99 per month. So, it seems crazy to provide those subsidies when the governmet could eliminate this waste and save money.

[consumersfirst]

Mr. Cooper, you have certainly struck a nerve here with those who support the rural telco industry ? probably the owners. I?m not so sure the program needs to be eliminated, because there?s plenty of work left to do to build efficient wireless networks out to rural America. The oversubsidy problem flows from 1300 little telcos, many or most of whom operate inefficiently with no market pressure to do otherwise. For example, each little telco has its own switch. This is so, even though some telcos serve less than 100 customers. In the bizarro world you refer to, the FCC provides subsidies to rural telcos on a system that is best described as ?the more you spend, the more you get.? Thus, rather than band together and share switch capacity, they all buy switches, because they can.

The key cause of universal service subsidies growing is not wireless entry ? it is precisely what you identified ? the FCC made a decision nine years ago to protect rural telcos from competition by ruling that they don?t lose subsidies when they lose customers. Under the current rules, a rural telco could lose all but one of its customers and retain 100% of the subsidies they collect today. I am not making that up. The decision to protect rural telcos was fine nine years ago ? but the FCC never intended it to be permanent. Since then, the rural telcos have received over $25 billion in subsidies.

You are also correct that every decision the FCC has made in this area recently has favored the incumbent telcos. It may be an attempt to simply destroy the program. The good news is that there are many decisions on the FCC?s books that confirm that subsidies are for consumers, not carriers. Subsidies are supposed to be distributed on a competitively neutral basis to the carrier that gets the consumer. And the courts have affirmed this. What we have here is an eleventh hour move by this administration to reverse all of decisions mandating competitive neutrality.

Wireless companies have been using the subsidies they are getting to accelerate construction of new cell sites in rural areas. Of course, this threatens the rural telco businesses, because people just don?t want the phone on the kitchen wall for voice service. They want wireless. In response, the rural telcos are hampering competitive entry, even though they don?t lose a dime of subsidy when competing carriers enter.

It truly is bizarro world, because they have convinced many influential members of Congress and a majority of the FCC that the real problem is competitive entry. One of their members stood up at a meeting on the Hill a week ago and said ?there really shouldn?t be competition in a lot of these areas.? A breathtaking statement that their own customers would probably not be happy with, especially since they pay into this system and are being denied the very benefits of efficient entry that the Congress intended to deliver when it adopted the 1996 Telecommunications Act. Universal service subsidies were intended to promote competition in rural areas so that monopoly structures could be broken and consumers could reap the benefits of choice.

The rural telcos understand the effects of competition and to date they have succeeded in convincing the FCC to protect rural ILECs at the expense of consumers. They have attempted to erase the pro-competitive mandates of the 1996 Act with industrial protectionism. As you properly point out, consumers are the losers here.

[consumersfirst]

This week revealed yet another example of how the FCC?s universal service policies favor landline telephone companies. One of the main reasons for capping subsidies to wireless carriers, and a driver of ?reform,? is the FCC?s recent conclusion that wireless is not a ?complete? substitute for wireline telephone service. This new conclusion was supported by a single citation to a 2005 study that measured cord cutting at only 8%. As confirmed by an article in this week?s USA Today: http://www.usatoday.com/money/industries/telecom/2008-05-13-landlines_N.htm , that number has doubled in less than three years. Clearly , the trend is accelerating. The FCC?s actions can only be described as driving while looking in the rear-view mirror. This may work in NASCAR, but this is critical federal policymaking that affects the lives of millions of Americans. The country, most of whom do not live in bizarro world, fully understands that wireless is the future of voice communications. The FCC?s current universal service policies subsidize fixed voice, the eight track tape of telecommunications, to the tune of over $3 billion per year. We need an FCC that understands that rural America needs high-quality wireless and broadband networks to survive economically and to compete, not only with our urban areas, but with the rest of the world. Federal universal service policies should be accelerating investment in these areas and inviting competitors to join the fray, not discouraging them. That was the entire purpose of the 1996 Act and here we are, twelve years later, still debating it?