An excerpt from a white paper, “Second Supplemental Declaration: Comments on the Price Cap Proposed Order,” prepared by Professor Mark Schankerman, Dr. Pierre Regibeau, and Charles River Associates:
The Fact Sheet issued recently by Chairman Wheeler addresses the key elements of the FCC’s proposed price cap regulation of BDS services. In this declaration, we focus on three key provisions in that proposal: 1) initial reductions to prices for ILEC DS1 and DS3 services by 11%, spread over three years (“reset”); 2) further reductions to DS1 and DS3 prices going forward by an annual “X-factor” of 3%, offset by inflation; and 3) application of these reductions through price cap regulation of DS1 and DS3 services in all geographic markets, including those in which there is extensive provision of Ethernet services by non-ILEC providers. In this declaration, we show that these elements of Chairman Wheeler’s proposal lie completely outside the range of policies that can credibly claim to be “evidence-based.”
The Fact Sheet does not identify the evidence or methodology used to justify this proposal. Based on a briefing provided to CenturyLink by FCC staff, however, it appears that the DSn rate reductions proposed in the Fact Sheet rely (at least as a starting point) on the BLS-KLEMS data for TFP and input price measurement, as we had originally proposed. But the draft order, as we understand it, would then apply an “adjustment factor” based on a comparison of the BLS-KLEMS data to X-factors computed by the FCC for particular points of time as far back as the 1990s.
Such an adjustment factor is unnecessary. While it is true that the BLS-KLEMS data includes broadcasting and wireless telecommunications, we showed in our supplemental declaration that the aggregation of broadcasting, wireless telecommunications, and wired telecommunications is not a concern. In fact, the BLS-KLEMS data provide a very conservative estimate of TFP growth for the DSn services at issue here.
The proposed adjustment factor also is deeply problematic and unjustified, for at least three reasons. First, this proposal has a fundamental methodological problem, as the draft order apparently would not make any adjustment to the input price series used to construct the BLS-KLEMS productivity numbers, and thus would create a mismatch between the productivity and input price series used for the reset and X-factor. Second, the X-factors the FCC generated in the 1990s were based on ARMIS data. These data, as explained below, reflect fundamentally arbitrary allocations of joint costs that have no justification from an economic perspective. Despite this concern, the draft order uses the difference between the ARMIS-based estimates of productivity and the BLS-KLEMS productivity numbers, for those earlier points in time to compute an “adjustment factor.” The draft order then applies this adjustment (fudge) factor to recent BLS-KLEMS estimates of TFP and uses that as the basis to compute the reset and the X-factor going forward. Third, the draft order apparently assumes, not only that this adjustment factor is meaningful (which we strongly dispute below) but also that it has remained the same over two decades which have seen dramatic changes in the structure of the telecommunications industry, and especially the growth of wireless and relative decline of wired services. In this Second Supplemental Declaration we will explain why these problems render the reset and X-factor proposed in the Fact Sheet invalid and indefensible.