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Regulatory Contagion?

I had the pleasure to be on a panel on Capitol Hill last Friday sponsored by the Advanced Communications Law and Policy Institute. The subject was whether the current financial crises and the likely push to rightly reregulate the financial services sector would lead to calls to reregulate the telecommunications sector (particularly broadband and wireless telephony). As James Gattuso, the moderator, noted, somewhat tongue in cheek, there are probably scores of such events taking place in Washington this month as industry after industry scrambles to figure out how to avoid the regulatory reaction that is sure to happen as Congress works to figure out how to avoid such a mess like this in the future.

There are two key questions here. Will telecom get caught up in this wave, and should it.  With regard to "will it," only time will tell. With regard to "should it," the answer is no.  But my reason for arguing this was quite different than that given by most of my fellow panelists.

They argued that the advanced telecom sector is now competitive and therefore should be spared any regulatory backlash. But I argued that the reason for restraint is actually just the opposite. It was precisely because there was too much competition and too little transparency in the financial services industry that the crisis emerged, and precisely because there is more concentration and a large degree of transparency in the telecom industry that a rush to reregulate would be ill advised.

As Columbia law professor Michael Heller argues in his excellent new book, The Gridlock Economy, the current financial meltdown stems in part from too many owners of mortgages. He writes, "There were so many partial owners of pooled mortgages that no one cared to act like an old-fashioned mortgage banker with careful underwriting and loan servicing…. Scattered owners of pooled mortgages could not easily reach agreement to restructure troubled loans." But it’s even worse, for U.S. banks themselves are too dispersed. Because of arcane, populist inspired laws, we have over 8,400 FDIC insured commercial banks. Compare that to Canada where there are essentially 5 major national banks. Not only does our banking system lead to inefficiency through lack of scale economies, it leads banks to be poorly capitalized and exposed to much higher risk than in Canada. This is one reason why Canada has largely escaped the mortgage crisis. Throw on top of that the fact that large parts of the market, especially derivatives markets, were largely invisible to regulators, and you had an industry that was ripe for problems.

In contrast, the telecom sector is made up of a much smaller number of national, well capitalized players – like AT&T, Verizon, Comcast, and Time Warner Cable. The actions of these companies are highly visible, with a host of consumer watchdog groups watching their every move, ever ready to blow the whistle on any behavior they question. And surrounding the entire industry is a state and federal regulatory system which still has significant influence, if for no other reason that firms in the industry are dependent on the oversight and good will of the Federal Communications Commission.

A major reason why Washington ignored the growing problems in the financial services industry was because most policy makers believed in the primacy of unfettered markets and the belief that competitive markets are the holy grail. This belief is not just some random notion that happens to be in vogue. Rather, it lies at the heart of the economic doctrine that prevails in Washington: neo-classical economics. Indeed, since the late 1970s, neo-classical economics, with its belief in the primacy of markets and the inherent limitations of government, has been the dominant economic doctrine shaping most of Washington’s thinking and action on the economy. Whether it’s the conservative version (supply-side economics) or the liberal version (sometimes called "Rubinomics," referring to the policies of President Bill Clinton’s Secretary of the Treasury Robert Rubin), the neo-classical doctrine has become so prevalent that for many it has become synonymous with scientific truth.

If we are to go forward into this brave new world it will be critical to have the right economic doctrine to shape Washington’s thinking so that it can more effectively determine questions like when does regulation makes sense, when it does not, and what kind of regulatory interventions make the most sense. In subsequent posts, I will be writing about what I think that doctrine – what ITIF calls innovation economics – should look like and what kinds of policies toward innovation we should be focusing on.

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