Baumol’s Contribution to Telecommunications Regulation

Telecommunications was traditionally considered a natural monopoly. However, in 1982 AT&T was required to give up its control of local telephone services. As economies of scale and scope pervade telecommunications services, the neoclassical perfect competition model could not be applied as a benchmark for regulation. Baumol’s theory of contestable markets was referenced in the design of the new telecommunications regulation regime that followed the AT&T divestiture. This chapter analyzes from a partially first-hand perspective Baumol’s contributions to the economics of telecommunications. After the AT&T breakup, a key issue to address was the access to the so-called last mile of copper wire owned exclusively by the local monopolies. Baumol together with his colleague Gregory Sidak claimed it was necessary to provide access to interconnection to all qualified applicants. Baumol and Willig proposed a pricing rule, which they argued ensures efficiency in the allocation of bottleneck input resources. The so-called parity-pricing formula is presented and discussed. The developments in the telecommunications industry that took place during the last 25 years are pointed out, particularly the role played in them by mobile phones. Interconnection was also a vital element for them, and Baumol’s contributions are still a point of reference in this area. The chapter concludes with some reflections on Baumol’s methodological views based on personal correspondence.