The Tragedy of the Telecommons: Government Pricing of Unbundled Network Elements Under the Telecommunications Act of 1996

J. Gregory Sidak & Daniel F. Spulber


Until 1996, local telephone markets had been treated as natural monopolies and thus subject to regulation. The Telecommunications Act of 1996 (the “Act”) seeks to introduce competition into these markets. One method the Act adopts to stimulate such competition is to mandate that incumbent local exchange carriers (LECs) provide access to their unbundled network, such as loops and switches. In August of 1996, the Federal Communications Commission (FCC) issued its First Report and Order, which established a pricing rule for UNEs. The FCC’s pricing rule sets the price for a UNE at its total element long-run incremental cost (TELRIC) plus a reasonable share of the incumbent LEC’s forward-looking common costs. We propose a pricing methodology to implement that rule based on a combination of what we call the market-determined efficient component-pricing rule (M-ECPR) and competitively neutral end-user charges. We assert that using the M-ECPR to price UNE access is more faithful to the language and intent of the Act than is the approach adopted by the FCC. We also maintain that the FCC misunderstood the efficient component-pricing rule when the agency rejected it as a basis of pricing UNEs.

After outlining our proposal for pricing UNEs, we argue that the FCC’s pricing rule is problematic because it prevents the incumbent LEC from recovering its total costs by denying any recovery of the LEC’s historical costs and ensuring that it will not fully recover its forward-looking costs. We then respond to criticisms of the M-ECPR by various economists and refute the assertions that the principal authors of the original efficient component-pricing rule rejected the M-ECPR in favor of TELRIC pricing for UNEs. We conclude by warning that the FCC’s pricing rule would discourage investment in local telecommunications networks and may eventually drive LECs into bankruptcy.

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