Cost Proxy Models and Telecommunications Policy ─ A New Empirical Approach to Regulation

The telecommunications industry defies easy characterization. The long-distancesector is highly competitive and the local exchange sector much less so, while digital transmissionand switching have blurred the distinction between traditional voice communication and thetransmission of video and data messages. Regulation of this industry has generally been considerednecessary because it has aspects of a natural monopoly.This book takes an empirical approach tonatural monopoly and the need for regulation of telecommunications. The centerpiece of the analysisis a sophisticated engineering cost proxy model, the local exchange cost optimization model (LECOM).The book, which is largely methodological, shows that a combination of LECOM, econometrics, andsimulations can aid policy discussion of such contentious issues as incentive regulation, naturalmonopolies, estimating the cost of interconnection among networks, and the obligation of universalservice. The book presents a theoretical framework to explain the incentives of firms and the powerof regulation and then uses LECOM to test the theoretical implications. The work is unusual in thatit applies the foundations of regulation theory to a model of an industry rather than applyingeconometric theory to historical cost data. The book includes a CD-ROM containing the data set theauthors used to analyze their model.