Productivity of the Regional Bell Operating Companies Under Rate-of-Return and Price-Cap Regulation

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Virginia Tech

In 1991, the Federal Communications Commission began regulating the tariffed rates of the nation's largest local exchange carriers under a new regulatory scheme: price-cap regulation. Price caps were intended to "remedy" the ills of traditional rate-of-return regulation. They were to provide incentive for the telephone companies to adopt innovative technology, cost-cutting measures and provide telephone services more efficiently. To test the effectiveness of this incentive, this study examined productivity of the regional Bell operating companies (RBOCs) under both rate-of-return regulation and price-cap regulation. A total factor productivity model was developed and productivity gains were calculated under both regulatory regimes. The assumption of total factor productivity was then relaxed and value-added productivity and labor productivity measures were also examined. The point estimates of productivity gains indicate that price caps have led to greater productivity gains. Although productivity gains varied greatly across individual RBOCs, use of total RBOC data indicated that average productivity gains improved 1.3 percent under price caps using the TFP model. Similar improvements under price caps were estimated using the value-added (1.1 percent) and labor productivity measurements (1.3 percent). However, because of the variability of the annual estimates, none of the productivity improvements are statistically significant. In conclusion, calculations of RBOC productivity gains suggest that price caps have led to more efficient use of inputs--labor; materials, rents and services; and capital--in the production of telephone company output. Yet, the statistical evidence is not strong enough to unequivocally support the assertion that price cap regulation has led to great productivity gains.

productivity, price cap regulation, telecommunications, rate of return regulation