After Price Caps

Abstract

Price cap regulation was proposed, and widely implemented around the world, to address the lack of incentives and other problems inherent in rate-base rate-of-return regulation. Price cap regulation was also a regulatory regime that was more hospitable to the introduction of competition into telecommunications. In North America, with a longer history of privately-owned, regulated telecommunications companies, price cap regulation was a substitute for rate-base rate-of-return regulation, while many other countries with newly-privatized telecommunications companies and liberalization on the agenda moved directly to price-cap regulation.By all accounts, price cap regulation has been successful. It has provided improved incentives to incumbent telecommunications companies and has provided them with the flexibility to respond to competitive market conditions. At the same time, price cap regulation has prevented incumbent firms from exercising market power or otherwise biasing the outcome of competitive markets, and it has delivered attractive prices to consumers.Economic regulation of telecommunications companies, or, indeed, any other utility with market power, is put in place to protect customers from monopoly pricing while at the same time permitting the regulated company to earn a profit adequate for it to continue providing service (often referred to as a fair and reasonable rate of return, or something similar). While rate-base rate-of-return can accomplish this, it has done so at the cost of inefficiency on the part of the telecommunications company. Price cap regulation, with its improved incentives, held out the promise, mostly realized, of permitting the regulated company to earn an adequate rate of return while at the same time promising customers lower prices than they could have expected under rate-of-return regulation. Furthermore, both rate-base rate-of-return regulation and price cap regulation had the broader goal of emulating the outcomes of markets if they were competitive. Because of the inefficiencies it engenders, rate-base rate-of-return regulation has done a poorer job of this than has price cap regulation, with its improved incentives and pricing flexibility.Initially, price cap regulation was simply a case of determining how consumer prices had behaved historically and, then, offering the regulated company price cap regulation in exchange for a cap that would offer consumers prices that were guaranteed to be lower, because of the cap, than they would have been in past trends under rate-base rate-of-return regulation had continued. In countries with no history of rate-base rate-of-return regulation, regulators moved directly to price cap regulation with a price cap trend that was anticipated to provide a better deal for consumers while at the same time providing adequate profits to the regulated firm. Over time, however, price cap regimes have become increasing complex, as extensive and involved calculations of inflation trends, productivity gains, and other technical price cap design issues have received more prominence. While the theory of price cap regulation remains the same, its cost and complexity has increased. This has occurred at the same time that more and more of telecommunications has become competitive and has either never been regulated (as is often the case with mobile communications or Internet access) or has been deregulated (as is often the case with long distance and some local services). The pace of competition has increased with IP technology permitting voice, data and video over integrated platforms. A more complex regulatory regime is, therefore, left to regulate less and less; the benefit/cost calculation for regulation has surely been affected. Furthermore, the continued application of price cap regulation, with its mandated reductions in prices, has the potential in this increasingly competitive environment to be anti-competitive if offsets are too high and the resulting prices are so low as to deter entry. This paper examines the next stage in the evolution of telecommunications regulation. The first step in this process is to determine exactly what parts of telecommunications service, wholesale and retail, still require regulation. This might include, for example, interconnection and local service in certain remote, high-cost areas that might not attract sufficient competition for deregulation. This limited scope for regulation, however, suggests a simplified regulation regime could be effective and efficient. In some cases, simple price ceilings, price floors, or price freezes may be sufficient, and, in other cases, cost-based rules or price adjustments if inflation is outside certain ranges may provide adequate protection to both consumers and the company. The paper will explore the nature of the services that still require regulation and will propose how to match the level and complexity of regulation with the remaining telecommunications services that require regulation. Regulatory choices will be considered in the context of technological and market realities, balancing the costs and benefits of regulation.Any continued regulation of telecommunications firms must be implemented carefully, as poor regulation has the potential to impair the viability of regulated firms, harm the competitive process, and saddle customers with higher prices, less innovation, and fewer choices that a competitive market would provide.