The Communications Workers of America ("CWA") represents 630,000 workers who are also consumers of telecommunications services. The majority of our members are employed in the telecommunications industry. In the telecommunications industry, CWA members work for firms providing local, long distance, cable, broadcasting, and wireless communications services. CWA is the leading union in the information age whose members are responsible for building, maintaining, and servicing customers on the information highway. CWA seeks to provide leadership on how the information technology industries will emerge in the years ahead, and is committed to ensuring that the profit motive is balanced with the public interest as this industry develops.
In these comments, CWA updates and refreshes previously filed formal and ex parte comments in response to the Commission's October 5, 1998 Public Notice. Our comments make these points:
We discuss the issues of the X-factor and pricing flexibility in more detail below.
I. The 6.5 Percent Productivity X-Factor Exceeds the Rate of Productivity Growth in the Industry
On September 17, 1997, CWA submitted to the Commission a report prepared by Dr. Dean Baker of the Economic Policy Institute (EPI) entitled "The Consequences of the FCC Price Cap Decision."(1) The Economic Policy Institute is an independent, non-partisan research institute based in Washington, D.C.
In his study, Dr. Baker analyzed the Commission's decision in its May 1997 Price Cap Fourth Report and Order. Dr. Baker concluded that the Commission's 6.5 percent productivity factor requires a reduction in access charges that cannot be supported by the expected rate of productivity growth in the industry. As a result, the price cap regime of the Price Cap Fourth Report and Order would cause incumbent local exchange carriers (LECs) to receive below market rates of return. This, in turn, would lead to potential disinvestment, with negative implications for service quality. Since the incumbent LECs have the option of investing in other sectors of the industry with higher rates of return, and also entering foreign telecommunications markets, the prospect of large scale disinvestment in the wireline network is real. This is certainly not a desirable result.
Dr. Baker concludes that the Commission's productivity X-factor of 6.5 percent annually is excessive for three reasons:
- Annual productivity growth in the industry in the period under consideration (1988- 1995) was close to 3 percent, not 6 percent;
- Increased competition is likely to lower the rate of productivity growth for incumbent LECs, not raise it; and
- There have been recent changes to the gross domestic product price index (GDPPI) which lower it relative to the true rate of inflation by approximately 0.2 percentage points annually. This means that the Commission ruling requiring a 6.5 percent annual decline in access prices measured against the GDPPI going into the future actually results in an annual X-factor of 6.7 percent.
Dr. Baker concludes that a productivity factor of 3.1 percent accurately reflects annual industry productivity gains over the study period.
A. Annual Productivity Growth in the Industry was Close to 3 Percent, Not 6 Percent.
In the Price Cap Fourth Report and Order, the Commission concluded that recent trends justified a 6.0 percent X-factor, with an additional 0.5 percent added to account for forward-looking annual productivity increases due to the impact of competition. Thus, the Commission mandated a 6.5 percent X-factor.
Dr. Baker's study finds that the Commission's own economist determined that industry productivity for the study period (1988-95) was 3.2 percent. However, the Commission set the X-factor at twice that rate. According to Dr. Baker, the Commission justified its decision because it claims that input prices for LEC carriers had fallen at the rate of 2.8 percent annually relative to prices in the economy as a whole. The Commission projected that this rate of decline in input prices could be expected to continue for the foreseeable future, and therefore incorporated this decline into its X-factor.
According to Dr. Baker, the Commission's analysis recorded that the decline in input prices is entirely attributable to a 2.6 percent decline in the cost of capital. This decline in input prices has already created a situation where the return on capital investment is lower for LECs than for other industries.
Including such projections in the forward-looking X-factor results in a continuing declining rate of return in the LEC industry, according to Dr. Baker, the projection of a continuing decline in the future will imply that the return will fall further relative to the economy-wide average. If this trend continues to the year 2000, the rate of return for the LECs will be just 5.1 percent. If such a decline actually occurs, it will inevitably lead to disinvestment in the industry, since firms will not be willing to invest at a sub-market rate of return. The fact that these sub-market rates of return are being projected for a period when the industry is being opened to competition should increased the likelihood of disinvestment, since the newly competitive environment will be adding a very substantial degree of risk to new investments in the industry. (EPI, pp 2-3).
In short, if incumbent LECs are required to reduce the price indices for access charges at twice the rate of actual productivity growth, based on a Commission assumption that return on capital will continue to decline below the economy-wide average, the Commission will have created a self-fulfilling prophecy.
B. The Impact of Competition
The Commission added 0.5 percentage points to the annual X-factor because of a presumed productivity premium associated with competition. But Dr. Baker points out that while competition may indeed offer some opportunities for increasing productivity, these are likely to be more than offset by four other factors that will lower productivity. First, the sectors in which the LECs will lose market share are likely to be the sectors with the highest profit margins. Second, as a result of losing market share, the incumbent LECs will see slower demand growth, which will limit the gains from the economies of scale that exist in the industry. Third, the Commission requires incumbent LECs to incur high costs to ensure compatibility with new entrants, including costs associated with number portability, OSS systems, etc. Fourth, competition itself adds substantial sales and marketing costs.
C. Inconsistent Prices Indices
Dr. Baker points out that changes made to the gross domestic product price index (GDPPI) have lowered it relative to the true inflation rate by 0.2 percent over the 1998-95 study period. Had this been incorporated into the Commission's own total factor productivity study, "it would have raised the measured rate of total factor productivity growth in the no-farm business sector by 0.2 percentage points." (EPI, p. 4)
The result, according to Dr. Baker, is that even if the Commission concluded that a 6.5 percent X-factor was warranted in comparing industry productivity to the GDPPI, "an annual 6.3 percent would be warranted when measured against the GDPPI that is currently in place." (EPI, p. 4)
D. The Impact of Setting the X-Factor Too High
Requiring rate reductions that are substantially greater than is warranted by productivity growth in the industry will lead to further reduction in the rate of return in the industry. According to Dr. Baker
The middle and long-term implications of sustaining rates of return that are below market levels will be disinvestment in the industry. Alternatively, it can lead the LECs to try to extract extraordinary concessions from their employees so that they can maintain reasonable rates of return. (EPI, p. 5)
That in turn would have serious negative implications for quality of service provided to consumers.
II. The Commission should adopt policies that provide incumbent local exchange carriers greater flexibility to set prices for access and other services as markets move to competition.
The Commission must ensure that asymmetrical regulation does not provide competitive advantages to some carriers but not to others. Under current rules, competitive LECs are free to negotiate volume and term discounts while incumbent LECs must charge the same price for access to all customers. Without this pricing flexibility, incumbent LECs cannot effectively compete for high-revenue customers. As more and more high-revenue customers shift their business to competitive LECs, incumbents with carrier-of-last resort and other universal service obligations will be required to spread their costs across a diminishing revenue base. This in turn will increase pressure on incumbent LECs to raise rates or to cut variable costs, including the costs of maintenance, capital investment, and labor. The result will be a decline in service quality in the public switched network and delay in network investment in new facilities, increased bandwidth, and new services.
Therefore, the Commission should adopt rules to ensure that as competition increases in the local exchange, incumbent LECs have pricing flexibility, including the ability to negotiate term and volume discounts, contract tariffs, and to respond to individual RFPs. This will ensure that incumbent LECs can compete with competitive local exchange carriers. CWA supports rules, such as those proposed by Bell Atlantic and Ameritech that provide increasing pricing flexibility as services or markets become competitive.
III. Conclusion
The Commission acted correctly in adopting a market-based approach to achieve the goals of the Telecommunications Act of 1996 to transition from implicit to explicit universal services subsidies. However, by setting the X-factor at a rate twice that of productivity growth in the industry, the Commission sets in motion a self-fulfilling prophecy in which reduced returns to capital in the local exchange market would lead to disinvestment, reduced service quality, or both. in the local exchange. The Commission has the opportunity to set an X-factor at a more accurate level during this proceeding. Furthermore, the Commission should adopt policies, such as those proposed by Bell Atlantic and Ameritech, that providing pricing flexibility in markets and services that are competitive.
Finally, the Commission must ensure that its decisions in this Access Charge review are consistent with decisions that it will make soon in its Universal Service proceeding. As the Commission noted in its May 1997 Access Charge Reform Order, " the conversion of the existing web of implicit subsidies to a system of explicit support would be a difficult task that probably could not be accomplished immediately" (Access Charge Reform Order, p. 9) and that therefore "the Act does not require, nor did Congress intend, that we immediately institute a vast set of wide-ranging pricing rules applicable to interstate and intrastate services provided by incumbent LECs that would have enormously disruptive effects on ratepayers as well as the affected LECs. (Access Charge Reform Order, p. 10).
The transition from an implicit to explicit system of subsidies must be accomplished with rules that ensure that we do not do damage to the goals of the 1996 Act of quality, affordable telephony and deployment of advanced services for all Americans.
Respectfully Submitted,
Communications Workers of America
By George Kohl
Senior Executive Director, Research and Development
Debbie Goldman
Notes
1. CWA Ex Parte Comments, CC Docket No. 96-262 and CC Docket No. 94-1, "The Consequences of the FCC Price Cap Decision," Sept. 17, 1997 ("CWA Ex Parte Comments").
