The Death of the Regulatory Compact: Adjusting Prices and Expectations in the Law of Regulated Industries

Abstract:     
Telecommunications regulation should be viewed as an attempt to solve the problem of financing large-scale public infrastructure over a sufficiently long period of time to pose significant and perhaps prohibitive amounts of risk. Investors are reluctant to commit capital to infrastructure if they cannot be assured of a reasonable return on their investment. Pricing rules in telecommunications are designed to protect incentives to invest in high-cost networks. Pricing disputes in the American telecommunications industry have raised serious questions over the extent to which public rules are governed by the United States Constitution's promise that private property shall not be taken for public use, without just compensation. These disputes are especially intense when they involve the price at which incumbent network owners must sell unbundled network elements to competitors seeking interconnection. This paper argues that attempts to enforce a pricing rule based on a utility's historic record of prudent investment lacks any plausible basis in American constitutional law. The misguided attempt to seek a constitutional solution to the problem of network pricing arises from a fundamental misunderstanding of the so-called regulatory compact. Rather, the problem of network pricing in highly complex and technologically volatile infrastructural industries such as telecommunications and electricity demands sophisticated legal tools such as price-level regulation, transitional pricing rules such as avoided-cost pricing and the long-run incremental cost rule for pricing unbundled access to incumbent networks, reverse auctions to fulfill universal service obligations, and tailored stranded cost recovery provisions. Reliance on a metaphorical regulatory compact has inflicted serious harm to the law of regulated industries. Accordingly, this obsolete metaphor should be discarded.

Keywords: Telecommunications, regulated industries, ratemaking, regulatory takings, regulatory compact, ECPR, TELRIC, public utilities, infrastructure, asset-specificity, Smyth, Hope Natural Gas, Verizon, Sidak, Spulber, Yoo

JEL Classifications: D42, K23, L50, L96, L97, L98, N41, N42, O38

Accepted Paper Series