ECON 100 Mar 10, 2008 Mergers, Natural Monopolies and Deregulation

Government Regulation Major categories –Anti-competitive behavior Price Discrimination, Collusion, Mergers –Natural Monopolies –Externalities Pollution Fishing, forestry, mining, oil drilling

Are All Mergers Equal? Conglomerate –Merger of firms in unrelated industries Vertical Merger –Merger of firms upstream/downstream from each other in production stream FCC: ownership of more than 1 media type Microsoft Horizontal Mergers –Firms in the same industry Telecomm industry –AT&T divestiture –Verizon/GTE merger; RBOC mergers Would the HHI be a valid measure of competitiveness?

Natural Monopolies What is the problem? –Unregulated: price like a monopolist –Set P = ATC => will not supply enough

Natural Monopolies How have they been regulated? –Rate-of-return regulation Usually by state utility regulatory commission Utility is authorized to earn a “rate-of-return” above its incurred costs –Issues with »What is a fair rate of return? »Averch-Johnson effect (incentive to goldplate costs) –Price caps (used to set LD rates) Price = base rate + inflation – productivity increases But what if demand shifts?

Deregulation Why deregulate an industry? –Difficulty in developing an effective regulatory strategy –Advances in technology reduce barriers to entry

Deregulation: Recent Examples Airline Industry (1978) Trucking and Railways (1980) Long distance telecommunications (1984) –AT&T divestiture Local telecommunications (1996) –Telecomm Act

Airlines Deregulation Civilian Aeronautics Board –Through 1978 Responsible for setting fares Assigning/approving routes Most competition was non-price –After 1978 Airlines responsible for setting fares, choosing routes –Airport terminals and airlines responsible for leasing gates Long term lease strategy

Airlines Deregulation Winners and losers –A. Kahn estimates that net savings were between $17B and $20B per year –Large cities Decreases in fares, more frequent service More traveled routes had direct service –Smaller cities Increases in fares, less frequent service Traveled through “hubs”

Telecommunications Act of 1996 The Act both deregulated and created new regulations. Congress forced local telephone companies to share their lines with competitors at regulated rates if "the failure to provide access to such network elements would impair the ability of the telecommunications carrier seeking access to provide the services that it seeks to offer."share their lines with competitors This led to the creation of a new group of telephone companies, "Competitive Local Exchange Carriers" (CLECs) that compete with ("ILECs" or Incumbent Local Exchange Carriers).Competitive Local Exchange CarriersIncumbent Local Exchange Carriers

Telecomm Act TCA permits new telephone companies to lease the incumbent telephone companies’ network facilities at wholesale prices far below costs. Rules encourage entry of firms that avoid building alternative networks and depend on subsidized networks’ facilities. –Few entrants that built alternative networks are now abandoning these networks (chart) for subsidized leased facilities.chart Because regulated wholesale prices are set far below costs in many states, incumbent telephone companies have also cut their investments. –Neither incumbent nor new entrant investing, equipment manufacturers have closed plants and industry employment has fallen by half a million jobs.

CLECs are abandoning their own networks to lease UNEs at bargain prices The recent increase in leased lines is coming at the expense of lines built and owned by CLECs themselves. UNE prices are set so low that they discourage CLECs from investing in alternative telecommunications infrastructure. Low UNE prices make the ILECs’ wholesale services unprofitable, which discourages continued ILEC investment. As a direct result of low wholesale prices, industry-wide telecommunications investment has fallen 40% over the last two years. This study finds that the fall in telecommunications investment results in an annual decline in economic output equivalent to $101 per average household annually. In contrast, the benefits of price reductions resulting from local competition are estimated to be $11.41 per household annually. This study finds finds that the economic costs associated with setting artificially low wholesale prices far outstrip the consumer financial benefit

Brookings Institute Robert Crandall of the Brookings Institutehas argued that the forced-access provisions of the 1996 Act have had little economic value, and the primary, sustainable competitive forces in phone and related, non-'radio', telecommunications are the wireline telephone companies, the cable companies, and the wireless companies.Robert Crandall of the Brookings Instituteforced-access The Act was claimed to foster competition. Instead, it continued the historic industry consolidation begun by Reagan, whose actions reduced the number of major media companies from around 50 in 1983 to 10 in 1996, reducing the 10 in 1996 to 6 in 2005.

So What was the Goal? Goals of regulation –Efficiency in Production –Promote Technological Innovation –Efficiency in Allocation