recognition to impede competition.

While regulation may be able to prevent some misallocation of costs and monitor high-risk investment financed through the ratebase, regulators cannot track all the cost and risk allocations in an integrated network of transmission lines, switches, computers, software, plant, personnel, marketing and advertising used jointly to provide monopoly local phone service and unregulated information services. As the General Accounting Office points out, the "FCC has struggled with [the development of costing principles] for over 20 years with what can only be characterized as limited success."6 With hundreds of billions of dollars at stake in upgrading the phone network to speed-up development of an information age infrastructure,7 the dangers of cost and risk misallocation involve the potential for substantial local rate increases.

Since regulation has been unsuccessful in preventing crosssubsidization, proponents of integrating new services within local networks have proposed new regulatory concepts that are theoretically superior. Although this " new wave" regulation sounds appealing open network architecture, comparably efficient interconnection, incentive/price cap regulation relies on contradictory assumptions and has never been tested in

1

it

6 GAO, Legislative and Requlatory Actions Needed to Deal with the Changing Domestic Telecommunications Industry, CED-81136 (September 24, 1981), at 86.

7 Robert Pepper, Through the Looking Glass, Office of Plans and Policy, FCC, OPP Working Paper No. 24, Washington, D.C., November 1988 at 6-12.

the marketplace.

The FCC's new method of dealing with a mixture of competitive and monopoly services provided through the network (i.e., Computer III and the Joint Cost rules) contradicts the Commission's rationale for replacing rate of return regulation with a "price cap" system. In support of its desire to promote network integration, the FCC developed a form of regulation that, rather than separating competitive from monopoly ventures (the Computer II separate subsidiary requirement), allows integration of all network services. Separation is no longer necessary, according to the FCC, because careful accounting practices make it possible to allocate costs without the danger of cross subsidy.8 However in its price cap proceeding, the Commission determined that cost allocation under rate of return regulation is so complicated, difficult and ultimately arbitrary, it is preferable to cap prices and adjust them based on automatic formulas.9 Similar regulatory schizophrenia is evident in the FCC's recent Special Access Order, where the Commission noted that:

a variety of reasonable allocations could be justified, because of ... the extent to which special access plant is used jointly and commonly to provide these services. Developing detailed cost allocation rules for these services would most likely be a futile attempt to achieve an illusory

8 In the Matter of Amendment of Sections 64.702 of the Commission's Rules and Regulations (Third Computer Inquiry), CC Dkt. No. 85-229 (Adopted May 15, 1986).

9 In the Matter of Policy and Rules Concerning Rates for Dominant Carriers, CC Dkt. No. 87-313, (Adopted March 16, 1989).

precision, given the wide range of allocations that would be reasonable for these services.10

In addition, the General Accounting Office points out that "The level of oversight that [the Commission] is prepared to

provide...will not provide telephone ratepayers or competitors positive assurance that FCC cost allocation rules and procedures are properly controlling cross-subsidy." 11

With this ambivalence toward cost allocation and the fact that the Computer III and price cap models of regulation have yet to be tested in the marketplace, it is hard to trust the FCC's regulatory intentions or abilities. CFA's vision of the optimal infrastructure for the development of information age services without jeopardizing affordable basic phone rates requires severely limiting the integration of information services within local exchange networks.

IV. FACTORS TO EVALUATE WHEN CONSIDERING NETWORK INTEGRATION

Although CFA believes traditional Communications Act policies, reinforced by the MFJ, have promoted efficient infrastructure development, we recognize that Congress would also like to consider enhancing network investment by promoting integration of new services within local exchange networks. We

10 See Investigation of Special Access Tariffs of Local Exchange Carriers, CC Docket No. 85-166, Phase II, Part I, released December 1, 1988 at 35.

11 GAO, Telephone Communications, RCED-88-34 (October, 1987), at 3.

therefore propose a number of factual inquiries designed to

evaluate whether the consumer dangers of network integration can be outweighed by potential benefits.

Proponents of integrating information services with the local exchange network argue that cost savings from network integration (i.e., economies of scope) would make it possible for the local Bell companies to offer more information services, at a lower cost, on an accelerated timetable, to more consumers than anyone else in the information business. Before accepting this assertion, CFA believes Congress must investigate and resolve a number of matters essential to protecting consumers' interests:

1. Congress must gather data to determine whether or not there are economies associated with integrating information services within the local exchange network. Given the dangers of crosssubsidization and overpricing basic local phone services associated with network integration, CFA believes Congress should not promote network integration unless this results in clear cost savings that will be passed on the consumers. We know of no clear empirical evidence that supports the cost-saving assertions of those who promote network integration.

2. If Congress determines that network integration would yield cost savings for any particular services, it should evaluate whether current regulatory tools can accomplish what none have adequately mastered in the past

prevention of cross

subsidization and overpricing of basic, monopoly services.

CFA

is skeptical that the FCC's untested new regulatory theories, which appear to be fundamentally inconsistent,12 can adequately prevent the Bell companies form overpricing monopoly basic phone services to subsidize potentially competitive information services. In addition, to protect consumers, Congress must investigate whether most of the hundreds of billions of dollars that may be invested in fiber optic local loop transmission equipment would end up in consumers' local rates through the FCC's "access charge" cost-causation theory and the Commission's

limitations on state cost allocation options.

3. To ensure that a ratepayer bailout, similar to the current Savings & Loan bailout, cannot arise, Congress must determine whether or not the extensive risks of speculative investment in information age services can be fully separated from the local carriers' regulated ratebase. CFA is fearful that it may be virtually impossible to insulate ratepayers from the financial losses associated with information services integrated within local exchange carriers' basic voice network. Given previous market failures in the information business (e.g., Knight-Ridder, Times-Mirror videotex failures) and Bell company losses in competitive ventures,13 it is essential that Congress proceed

13 Rodney Blythe, Summary Report on the Regional Holding Company Investigations, National Association of Regulatory Utility Commissioners, September 18, 1986, at 8.