What is the effect of regulation on investment?  At a high level of abstraction, it is impossible to say.  Rate-of-return regulation, for example, is criticized by economists for possibly encouraging too much investment—a principle known as the Averch-Johnson Effect.  On the other hand, if a firm fears that the regulator will alter the rules in a way that reduces the ability to earn profits on large, long-term capital investments, then the incentive to make such investments is reduced.  Importantly, the issue is not, as some claim, just about “regulatory uncertainty.”  There could be great uncertainty about future rule changes, but if the expectation is that rule changes will increase average profitability, then investment may actually be encouraged by the uncertainty.  Alternately, if there is great certainty that future rule changes will reduce average profitability, then investment is discouraged.  Accordingly, the issue is not merely regulatory certainty or uncertainty, but whether government is trending towards more heavy-handed or light-touch and deregulatory policies.  Section III of our paper entitled The Broadband Credibility Gap published in Commlaw Conspectus presents a theoretical analysis of this issue.

The relationship between regulation and investment is important because investment is important.  Private investment drives the economy, and private investment in broadband facilities is expected to have a particularly potent effect on economic growth.  In the current economic environment of high unemployment, investment is also important because it often (but not always) creates jobs.  In a recent paper, we showed that private investment has a sizeable effect on job creation in the macro economy, particularly when the economic growth is slow.  In another paper, we estimated that each million dollars invested in the ICT sector produces 10 jobs in that sector and perhaps another 12 jobs throughout the rest of the economy (for a total of 22 jobs per million invested).  And, of course, with investment in modern broadband infrastructure, we get other important societal benefits including, as we have shown,  the reduction of depression among the elderly or keeping unemployed people from becoming “discouraged” and leaving the workforce altogether.

With high unemployment, politicians certainly want to claim their policies promote investment and, consequently, jobs.  Take, for example, a recent statement by Federal Communications Commission Chairman Julius Genachowski, who claimed that investment in the U.S. wireless sector “is responsible for creating 1.5 million U.S. jobs in recent years.”  While the Chairman no doubt wants to share in the credit, assessing the FCC’s influence on investment, or any administration’s influence for that matter, requires a counterfactual analysis.  It is not enough to say that investment is up, or down, or that such-and-such investment created such-and-such jobs.  The relevant issue is what influence a particular regulatory agenda has on investment incentives relative to a different and perhaps less-regulatory agenda.  In what direction is regulation trending?  In that regard, the relevant question is whether firms expect future regulation to be more or less favorable to making profits from large-scale, sunk investments.

While regulators are often loath to lay down the details of a particular agenda, lest they be boxed in, the process of regulatory decisionmaking often exposes a tendency.  In some cases, these patterns are explicit.  Take, for example, the statement of former FCC Chairman William Kennard,

… with competition and deregulation as our touchstones, the FCC has taken a hands-off, deregulatory approach to the broadband market. … We need an intentional restraint born of humility.  Humility that we can’t predict where this market is going.  Indeed, who among us could have predicted the incredible advances of the past few years?  Who at the beginning of this decade could have predicted the embrace of e-mail by all ages, the birth of the World Wide Web, the advances in communications technology?

Of course, anyone could make such a statement, regardless of their policies.  But Chairman Kennard put his money where his mouth was, further noting,

We approved the AT&T-TCI deal without imposing conditions that they open their network.  We did this because there is no sign that as this nascent market matures that the cable operator has an incentive to deny ISPs access to their platform.  There is no sign that consumers do not have other avenues to get broadband connections if they don’t want to use cable.  And finally, it is not clear that the perceived benefits of mandating open access outweigh their apparent economic and technological costs.

These statements sent a bold signal to broadband service providers that the FCC did not intend to over-regulate their networks.  The agency, going forward, “will [let] a competitive marketplace thrive.”

Contrast Mr. Kennard’s approach with the signals sent by the current FCC.  In the Open Internet Rules, for example, the FCC’s willingness to regulate broadband networks did “not depend upon broadband providers having market power with respect to end users,” and that the regulations were not intended “to prevent[] only those practices that are demonstrably anticompetitive or harmful to consumers.” Competition, in other words, is not enough to avoid regulation, and behavior that is beneficial to consumers is not enough to avoid regulation.  The current FCC’s signal is obvious—it will be the policy of the agency to use the heavy-hand of regulation on broadband networks regardless of the circumstances.

In our Broadband Credibility Gap paper we published two years ago, we detailed a few of the instances of the current Administration’s regulatory proclivities in the broadband arena.  Since that time, the agency has continued to careen down the path of more regulation, with much of it being direct or indirect price controls.  Let’s look at just a few examples:

First and foremost, we have the FCC’s Open Internet Rules.  Like it or not, such rules are unambiguously price regulation, because broadband service providers (“BSPs”) are specifically prohibited from charging a positive price to content firms (e.g., Netflix), even though these services impose the greatest costs on the network.  Instead, BSPs are forced to recover these costs directly from the consumer; an alternative we have demonstrated may make us all worse off.  Just because the regulated rate is “zero” does not imply that regulation is harmless.  Larry went into great detail about this very point in a blog post dated January 31, 2012, which I commend for your reading pleasure.

Equally as important, the FCC in the Open Internet Order made it clear it was willing to sabotage the investments in the wireless industry made under one set of rules by threatening to change the rules in the future.  Indeed, despite the fact that wireless carriers had spent billions on unencumbered spectrum licenses, the FCC explicitly stated it could encumber that spectrum whenever it wished to do so:

Even after licenses are awarded, the Commission may change the license terms “if in the judgment of the Commission such action will promote the public interest, convenience, and necessity.” The Commission may exercise this authority on a license-by-license basis or through a rulemaking, even if the affected licenses were awarded at auction. (Open Internet Order at ¶ 133 and citations omitted.)

More troubling was the fact that the Commission appeared to dismiss out of hand the argument that changing the rules post-auction would violate the contractual nature of the auction.  According to the Commission, the agency,

retains the statutory authority to impose new requirements on existing licenses beyond those that were in place at the time of grant, whether the licenses were assigned by auction or by other means.  (Id. at ¶ 135, citations omitted).

In other words, the FCC made it abundantly clear to all investors, and did so in a setting where such threats were entirely unnecessary, that is has the authority to sabotage sunk investments at will.  Economic theory makes it clear that such threats diminish investment incentives.

Let’s continue and consider the FCC’s attempt to create a homogenous cable set-top box by issuing a Notice of Inquiry to create a new “AllVid” paradigm.  As we demonstrated, given the economics of the problem, the AllVid paradigm—like the CableCard paradigm before it—is doomed to fail.  If anything, the Commission should seek to sunset the statute pursuant to the provisions of Section 629.  Rather than taking the opportunity to encourage investment by sunsetting an outdated regulatory idea, however, the Commission continues to hang the possibility of AllVid over the industry like a sword of Damocles.

Then we have the FCC’s infamous Phoenix Forbearance Order.  The 1996 Telecommunications Act was supposed to be “pro-competitive” and “deregulatory.”  As we demonstrated in great detail, however, the standard for forbearance set in the Phoenix Order effectively renders Section 10 of the Act moot by establishing a forbearance threshold—price equals marginal cost—that is impossible to satisfy in most (if not all) communications markets.  (For those interested in exploring this issue further, I presented this paper at our 2010 Symposium and the video may be viewed here.)

More recently, we have the FCC’s Data Roaming Order, where if parties cannot come to an agreement, the Commission will arbitrate and subjectively decide what is “commercially reasonable” using no less than SEVENTEEN different factors.  As Larry explained in his January 31, 2012 blog post, however, the clear bias contained in the Data Roaming Order cannot but help to prejudice negotiations.  In Paragraph 79 of the Data Roaming Order, the Commission outlines its review process as follows:

… if negotiations fail to produce a mutually acceptable set of terms and conditions, including rates, the Commission staff may require parties to submit on a confidential basis their final offers, including price, in the form of a proposed data roaming contract. These submissions would enable Commission [to order] the parties to enter into a data roaming agreement pursuant to the terms of the complainant’s [] final offer.

Given the explicit bias of the agency (to the complainant), those companies seeking roaming agreements will surely shave their best offers by a significant amount.  Again, despite the fact that the Chairman’s Office described this order as a “lighter touch approach”, the Data Roaming Order unambiguously imposes price regulation on the wireless industry and, in doing so, chooses a biased regulatory approach threatening those making investments in favor of those trying to avoid them.

Finally, we have the FCC’s recent Notice of Proposed Rulemaking to promote interoperability in the 700 MHz band.  While Larry went into great detail about the “fishyness” of the FCC’s logic behind that NPRM in a blog post dated March 28, 2012, more germane to this blog post is the following quote from the Commission:

if the industry fails to move timely toward interoperability once interference concerns are adequately addressed (by regulatory action or otherwise), additional regulatory steps might be appropriate to further the public interest.  (Id. at ¶ 49.)

And what would this regulation be?  The FCC would require licensees “to use only mobile user equipment that has the capability to operate across all of these blocks.” (Id. at ¶ 50.)  Again, the agency explicitly presents the threat of heavy-handed and costly solutions by threatening to mandate the type of equipment a firm must use.  Such heavy-handed interventions are a consistent theme of the Genachowski administration, and perhaps his legacy.

To paraphrase Section 706 of the Communications Act, the FCC is supposed to “encourage the deployment” of advanced telecommunications capability to all Americans by “remov[ing] barriers to infrastructure investment.”  Yet, at present, perhaps the greatest deterrent to infrastructure investment is this FCC’s persistent threats of heavy-handed regulatory interventions in a market that is performing well by most standards.  Given this FCC’s legacy of heavy-handed regulation, I would recommend that broadband investment not be one of the Obama Administration’s central talking points during the upcoming election cycle.

 

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