Is Structural Separation of Incumbent Local Exchange Carriers Necessary for Competition

Abstract

Although competitive local exchange carriers (CLECs) collectively have gained considerable market share since the passage of the Telecommunications Act of 1996, many entrants into local telecommunications have stumbled or failed. Some argue that competitive local telephony will eventuate only if the incumbent local exchange carriers (ILECs) place their wholesale and retail operations in structurally separate subsidiaries. By mid-2001, several states began proceedings on mandatory structural separation, and influential members of Congress introduced legislation mandating structural separation. In this Article, we analyze, and reject as unpersuasive, the putative benefits of mandatory structural separation. Such regulatory intervention is unnecessary to prevent discrimination against unaffiliated retailers of telecommunications services. Nor would mandatory structural separation lower wholesale discounts or increase the CLECs' market share. Plausible hypotheses for the CLECs' problems do not require the assumption of anticompetitive behavior by the ILECs. Apart from producing no discernable benefits to consumers, mandatory structural separation would entail a substantial social cost in terms of forgone coordination of investment and production and forgone economies of scope. Moreover, mandatory structural separation would harm consumer welfare and reduce resources for investment by facilitating an anticompetitive strategy by the ILECs' largest rivals to raise the ILECs' costs of providing local telecommunications services. Policy makers should reject proposals for mandatory structural separation of the ILECs.