Fresh off the heels of a scathing critique by Judge Williams of the economic analysis in its Open Internet Order, the FCC needs to avoid any appearance of further “economics-free” rulemaking. In a mind-numbingly complicated and extended proceeding to decide how to retain the agency’s foothold over business data services (BDS), the FCC released three economic statements from its staff this week that purportedly justify the draconian actions it wants to take in that space. The agency even went so far as to reveal that it subjected its core economic analysis to peer review. A boon for economics, right?
Not exactly. The FCC is merely paying lip service to infusing its decision-making with economic analysis. As revealed in the peer review, the flaws in the underlying economic work that undergirds the proposed regulation of BDS (previously called “special access” services) are potentially fatal, rendering the analysis useless as the basis for the agency’s proposed regulations.
At least one party directly affected by the agency’s move has already expressed outrage over the broken process by which the FCC subjected its economist’s work to peer review, including the FCC’s decision not to release the peer review responses until comments were due. Rather than piling onto the FCC’s process errors, I’ll focus on the merits of the FCC’s economic support.
By way of a quick history, the FCC retained an external economist, Dr. Mark Rysman, Professor of Economics at Boston University, to establish “direct evidence of market power” in the supply of BDS in its Further Notice of Proposed Rulemaking (FNPRM). A finding of market power is critical to the FCC’s endgame, as the agency cannot compel a BDS provider to share its facilities at cost-based rates with a rival, nor subject its retail rates to price-cap regulation, in the presence of competition.
But as George Ford so ably points out, Rysman’s paper, which appears as Appendix B to the FRNPM, “says nothing about market power.” That BDS markets served by a single BDS provider exhibit greater prices on average than markets served by two providers does not rule out the possibility that BDS providers earn zero profits in so-called monopoly markets—that is, they generate revenues just high enough to cover their fixed costs. Moreover, Rysman’s estimates of the difference in prices between monopoly and competitive markets are not headline-grabbing: Before considering any critiques of his methodology, competition allegedly brings a modest price reduction of roughly ten and three percent for DS3 lines and DS1 lines, respectively.
The FCC sought peer review of the Rysman study by Andrew Sweeting, Associate Professor of Economics at University of Maryland, and Tommaso Valletti, Professor of Economics at Imperial College London. Interestingly, neither reviewer seems to be persuaded by Rysman’s empirical analysis.
Both reviewers criticized Rysman for relying on a cross-sectional database of buildings in 2013, rather than on panel data, which would contain prices for each building over a span of years. Sweeting notes that an “obvious concern” of Rysman’s limited dataset is the possible presence of “unobservable differences across customers that are correlated with both prices and competition by using census tract or county fixed effects,” thereby potentially contributing to biased estimates of Rysman’s competition variable. Rysman’s estimated price effects from competition could be upwardly biased, for example, if as Sweeting notes, cable providers “might be particularly good at picking off customers who want fancier services from the ILEC, so that in locations with [cable] competition, ILECs are left serving customers who are purchasing relatively cheap products. . . .” Sweeting concludes that “most economists would regard within-customer-over-time changes in prices, that could have been identified and estimated with panel data, as more compelling.”
In addition to the problems relating to the cross-sectional nature of his data, Sweeting identifies deficiencies in Rysman’s econometric model. For example, Sweeting notes that many of the contracts in Rysman’s dataset “are likely to have been negotiated some time prior to 2013, when local competition may have been different.” Sweeting notes that there has been significant growth in fiber-based cable networks since 2013, which suggests that extant relationships between prices and competition might no longer hold in 2016. He faults Rysman for failing to control for contract terms, such as duration, additional equipment, or contract date, all of which could explain pricing variation for the same products. Sweeting is also critical of Rysman’s assumption that a lack of a competitor’s presence in the building indicates limited competition, even when a competitor exists in the same census block.
Valletti also addresses the limitations of Rysman’s cross-sectional dataset: “[T]he question remains whether it is still possible that unobserved factors that can affect prices (particular demand and supply characteristics) differ within the census tract, and could drive the entry of CPs.” If so, and if Rysman failed to control for the “endogeneity of competitive entry,” then his estimates for the competition variables could be biased.
But perhaps Valletti’s most devastating critique occurs on page five, when he ponders whether prices per building (Rysman’s dependent variable) are even capable of responding to competitive entry given that DS1 and DS3 prices are based on tariffs:
If a service is tariffed, which I understand is true, for instance, of DS1 and DS3 services, then that service must be generally available to all at the same price. I also understand that the carriers can and do under the tariff differentiate services based on geographic locations, and that under the tariff prices can also vary, for instance, with volume, term commitment, and quality of SLAs. But if one could control for all these factors, the prices should not change with the number of competitors, as the same conditions must be offered to everyone. So my main point here is to understand why – having controlled for all the “right” factors – competition should have a role for tariffed services. Else the interpretation of the regression results could be substantially different: if, say, regulated prices could not react at all to the number of competitors, then the present statistical findings are simply pointing to the spurious correlation that competitors seem to enter in particular buildings where particular contractual elements (not observed by the econometrician) are present.
Put differently, Rysman’s basic premise that DS1 and DS3 prices should be correlated with competitive circumstances makes no sense so long as prices are tariffed and available to all comers at the same terms.
In seeming disregard to these significant criticisms, the FCC presses forward with its radical proposal, which would subject both telcos (incumbents) and facilities-based entrants (cable companies) to price controls. None of the economic statements released by the staff this week credibly addresses the critical errors reviewed here. Peer review is great in theory, but if doesn’t cause the Commission to alter its approach, then what good is it?