Constant and Variable Productivity Adjustments for Price-Cap Regulation

Abstract

It has been suggested by several studies¹ that price-cap regulation with an adjustment formula for inflation and productivity is capable of offering incentives for regulated firms to improve their efficiency by minimizing costs under existing technologies as well as by improving technologies via increased innovation. It has also been suggested that the allocative efficiency of prices may improve under the price-cap regime, and that considerable social welfare improvement may result from it and from the greater efficiency of the production processes of regulated firms. Whether and to what extent the FCC’s now emerging price-cap regulation for U.S. telecommunications will deliver these benefits depends, among other things, on how well its design and execution are adapted to the behavioral characteristics of input prices and productivity in the regulated sector of the U.S. telecommunications industry. Utilizing a broad range of information from empirical evidence on the productivity performances of regulated telecommunications carriers in the past to econometric productivity analysis, this article explores what is, paradoxically, perhaps the most important as well as the least understood aspect of price-cap regulation: productivity adjustments.²

For example, NTIA (1987), Vogelsang (1988), FCC (1987, 1988).

The first manuscript of this article was written as an immediate reaction to the FCC’s Note of Proposed Rulemaking in August 1987. An improved and extended version, identical in contents but somewhat different in appearance from the present article, was presented at the Massachusetts Institute of Technology in July 1988.