Brookings: Experts - Robert W. Crandall

To Reduce Lawyers' Drag on Growth, How about a Law PhD?

Clifford Winston and Robert W. Crandall — Thu, 14 Mar 2013 00:00:00 -0400

A crisis is a terrible thing to waste, so the saying goes. So is a mind – a keen scholarly legal mind. Fewer students seem to be interested in entering law school as can be seen by the 50% decline in applications. But the crisis in legal education may have a silver lining: as most law schools are cutting their student enrollments, Chicago, Vanderbilt, and Yale law schools are attracting students to new legal doctoral programs. Despite what one might think, PhD lawyers could be a good thing for the economy: they will be trained to produce research that could help eliminate costly inefficiencies caused by public policies—ironically, especially those that increase the demand for lawyers. Indeed, if economics research is correct that an economy’s growth slows as more lawyers comprise its workforce, then the payoff from such research could be substantial.

Last year, the University of Chicago established the Coase-Sandor Institute for Law and Economics and is currently developing a joint J.D./Ph.D. in law and economics. Vanderbilt Law School will welcome students to its new Ph.D. program in law and economics in 2014. And this fall, Yale Law School will welcome students to its new Ph.D. program in law. Other major law schools are likely to follow, offering similar doctoral programs in the coming years.

Law is at the core of public policy and indeed is the bedrock of democratic government; thus, doctoral programs in law will require graduates to apply analytical tools that produce original contributions to knowledge about the causes and effects of a vast array of public policies. As a result, these newly minted PhDs will develop powerful, empirically testable findings that could significantly benefit society by maximizing the benefits and reducing the costs of government intervention in our economics lives.

Since the late 1950s and early 1960s, when faculty at Chicago and Harvard first used quantitative methods to analyze whether economic regulations of various industries were having their intended effects of controlling monopoly pricing, scholars have assessed countless public policies. However, we have little knowledge of the quantitative—and even qualitative—effects of many important policies, especially those where lawyers may benefit at the expense of society at large. Those laws and regulations would therefore be ripe for analysis by law doctoral students due to their in-depth knowledge of the legal system and the various roles that lawyers play in it.

For example, lawyers are central to the resolution of intellectual property disputes. Indeed, lawyers are routinely called upon to write patent applications because applicant companies know that the validity of most patents will eventually be determined in a federal court. While lawyers benefit from a patent system that generates demand for their services, there is little evidence on whether the lawyer-rich patent system provides benefits that outweigh its costs.

There’s also America’s expensive liability system. Lawyers are generally paid on a contingency-fee basis, and because the cost of defending a suit is high, defendants often pay the plaintiffs (and their lawyers) to settle before trial. The cost of the U.S. tort system has been estimated by Towers Perrin to be at least two percent of GDP, but there is little evidence on whether the benefits of this system exceed its cost. Thus policymakers have little guidance on how the system should be reformed to reduce its costs without compromising any incentives it may provide for individuals and firms to behave in a socially desirable manner.

Another example: financial regulation reform in the wake of the Great Recession. Highly-paid lawyers representing various interests have engaged intensely with federal regulatory agencies to shape the implementation of the Dodd-Frank Act. Unfortunately, little scholarly knowledge is available to guide how, if at all, financial regulation should be reformed and how best to prevent a repeat of the events that led to the financial crisis. As a result, the merits of the Act are being strongly questioned and certain policymakers and industry executives are calling for its repeal even before it is fully implemented.

Finally, reform of health care has emerged as one of the most important policy issues of our time. And while research has yet to find a “magic bullet” to lower the costs of the health-care delivery system without significantly reducing the quality of care, lawyers are fully engaged in opposing any measures that would limit their fees or impose caps on damages in medical malpractice cases.

Graduates and faculty of the new doctoral programs in law have an opportunity to fill many gaps in our understanding of the effects of policies that are at the center of their expertise and to explain how the symbiotic relationship between private-sector lawyers and policymakers, who often come from legal backgrounds, have adversely affected policy outcomes.

If lawyers are truly a drag on the nation’s growth in the course of influencing and benefiting from inefficient public policies, then doctoral programs in law have come at just the right time.

Authors

Publication: Forbes

Image Source: Darren Greenwood

The Law Firm Business Model Is Dying: How Regulations Are Stifling the Legal Profession

Clifford Winston and Robert W. Crandall — Mon, 28 May 2012 00:00:00 -0400

On Monday night the century-old law firm of Dewey & LeBoeuf filed for bankruptcy—following in the footsteps of other venerable firms such as Howrey & Simon, Heller Ehrman, Coudert Brothers, and Brobeck, Phelger and Harrison. It is easy to think that greedy lawyers are getting their just desserts. But this should not blind us from seeing that there is a better way for America's law firms to do business.

The problems these firms face today are twofold: Large clients are increasingly using in-house counsel to reduce costs, and the public is increasingly taking the do-it-yourself route given the growing access to a variety of legal services and documents on the Internet. The rational response would be for new, low-cost legal firms to start up, and for incumbents to reduce costs and attract new clients by providing innovative services.

But that is happening only to a limited extent because of state licensing requirements and American Bar Association (ABA) rules. Deregulation could open the market and transform the legal industry for the better.

Regulatory barriers have hamstrung other sectors of the economy in the past until the arrival of deregulation. For example, Interstate Commerce Commission (ICC) regulations raised railroad rates for decades after its inception in 1887. But with the proliferation of motor vehicles, trucks began to capture a large share of rail freight traffic.

Then trucks were included under the ICC's regulatory umbrella in 1935, to prevent railroads' freight market share from continuing to erode. But by raising trucking rates, the ICC induced some shippers to buy and operate their own trucks, exacerbating rail's woes. Similarly, Civil Aeronautics Board regulations elevated airline fares, and by the late 1950s—when interstate highway travel was possible—the high fares limited the percentage of seats filled with paying passengers.

The deregulation of transportation that began during the late 1970s enabled motor, air and rail carriers to reduce costs and, particularly in the case of railroads and airlines, to regain market share by offering consumers lower prices and better service.

How have regulations caused the demise of long-established "white-shoe" law firms? Much legal work is performed by associates, who in most states must graduate from a law school accredited by the ABA and pass a state bar examination. This form of licensing significantly limits the flow of new legal practitioners. It also means would-be lawyers must make a substantial upfront educational investment in money and time that must be recouped in high salaries later.

Such salaries can be and are paid because licensing limits competition in the legal profession, and because partners derive much of their own inflated earnings from associates' work.

But when law firms are under pressure to reduce costs, it is difficult for the partners to significantly reduce their reliance on associates without severely affecting their ability to serve clients. Efforts to outsource some tasks have met with only limited success.

While law firms can and do get bank loans, ABA regulations prohibit banks, private-equity firms or other corporations from owning or having an ownership stake in a law firm. This limits a law firm's financing options and raises its capital costs. Dewey's collapse has been attributed to the firm being highly leveraged and unable to attract investment from businesses outside the legal profession.

Law firms are aware of the value that professional business managers can add to their operations. But regulations that prohibit the ownership of law firms by nonlawyers prevent those firms from fully realizing the value of managerial skills and oversight that professional management could bring.

Finally, because regulations prevent corporations from providing legal services other than their own legal counsel, a law firm today cannot realize efficiencies or make more money by merging with a firm outside the legal profession to provide financial and accounting services, for example, along with legal services.

Eliminating regulations on who may provide legal services and who may own and operate a law firm could result in substantial efficiencies. Deregulated firms and new legal entities could reduce costs by hiring a variety of people to provide legal services—some who have completed three years of law school and some who have not.

Such firms would be better positioned to explore the substitution of capital for labor—for example, by accelerating the use of sophisticated Web searches as a substitute for manual document searches, and by using other information technology to ensure that corporate clients comply with government regulations.

New firms not necessarily owned by lawyers would bring new ideas, new technologies, new talents, and new operating procedures into the practice of law. This process has certainly happened elsewhere, the way Freddie Laker and Southwest Airlines brought new operating efficiencies to the airline industry, or the way satellite and cable brought a multitude of new programming to a once-stagnant television industry controlled by three broadcast networks.

As legal fees fell and services improved and expanded, many corporate clients would begin to downsize their internal legal departments. They would go back to relying principally on outside legal help, much as shippers have returned to deregulated for-hire trucking companies and less-regulated railroads. American businesses would reap the economies of specialization and technical progress that a rejuvenated legal-services industry could provide.

Authors

Publication: Wall Street Journal

Image Source: © Eduardo Munoz / Reuters

Time to Deregulate the Practice of Law

Robert W. Crandall and Clifford Winston — Sun, 21 Aug 2011 00:00:00 -0400

The job market is not looking bright for Americans of all walks of life, even Ivy League college graduates and those with advanced degrees. For example, a new wave of law school graduates has just taken state bar examinations, which they must pass to obtain a license to practice law. But after accumulating as much as $150,000 in law school debt (likely on top of undergraduate debt), many of those test-takers are concerned that jobs in their field are vanishing.

Is there really an excess supply of lawyers? The Senate Judiciary Committee is investigating the subject while the New York Law School and the Thomas Cooley Law School in Michigan are being hit with class action suits claiming that they fraudulently inflated employment statistics to lure prospective students. But the solution proffered by many in the legal community—to put new limits on entry into the legal profession—is not the answer and will make the problem worse over the long term.

The reality is that many more people could offer various forms of legal services today at far lower prices if the American Bar Association (ABA) did not artificially restrict the number of lawyers through its accreditation of law schools—most states require individuals to graduate from such a school to take their bar exam—and by inducing states to bar legal services by non-lawyer-owned entities. It would be better to deregulate the provision of legal services. This would lower prices for clients and lead to more jobs.

Occupational licensing limits competition and raises the cost of legal services. But those higher costs are not justified when the services provided by lawyers do not require three years of law school and passing a particular test. One example is LegalZoom.com, an online company which sells simple legal documents—documents that should not require pricey lawyers to prepare—like do-it-yourself wills, uncontested divorce documents, patent applications and the like.

The competition supplied by new legal-service providers, who may or may not have some type of law degree and may even work for a non-lawyer-owned firm, will not only lead to aggressive price competition but also a search for more efficient methods to serve clients.

Every other U.S. industry that has been deregulated, from trucking to telephones, has lowered prices for consumers without sacrificing quality. For example, most regulated large airlines used to operate with large numbers of empty seats, particularly on longer routes. Once deregulation allowed Southwest Airlines, a smaller regional carrier, and other new carriers to offer service on any route, airline fares declined dramatically and the industry operated with far fewer empty seats and more employees. Deregulation of wireless, cellular telephone services and the entry of new carriers has led to the lowest wireless rates in the developed world and stimulated huge expenditures and associated employment in constructing new networks.

Entry by new firms—sometimes from other industries—spurs innovation. The legal industry will be no different. Ford, Honda and Toyota moved into motor vehicle production from bicycle, motorcycle and farm-equipment production, respectively. More recently, Apple moved from computers into mobile telephones (the iPhone), putting enormous competitive pressure on industry giants such as Nokia, Motorola and Research in Motion (Blackberry). The resulting innovations improved quality and lowered prices while also expanding employment.

Allowing accounting firms, management consulting firms, insurance agencies, investment banks and other entities to offer legal services would undoubtedly generate innovations in such services and would force existing law firms to change their way of doing business and to lower prices.

Entry deregulation would also expand individuals' options for preparing for a career in legal services, including attending vocational and online schools and taking apprenticeships without acquiring formal legal education. Established law schools would face pressure to reduce tuition and shorten the time to obtain a degree, which would substantially reduce the debt incurred by those who choose to go to those schools.

Supporters of occupational licensing to restrict the number of lawyers in the U.S. are wrong to assert that deregulation would unleash a wave of unscrupulous or incompetent new entrants into the profession. Large companies seeking advice in complex financial deals would still look to established lawyers, most of whom would probably be trained at traditional law schools but may work for a corporation instead of a law firm.

Others, seeking simpler legal services such as a simple divorce or will, would have an expanded choice of legal-service providers, which they would choose only after consulting the Internet or some other modern channel of information about a provider's track record. Just as the medical field has created physician assistants to deal with less serious cases, the legal profession can delegate simple tasks.

The track record of deregulation naysayers is hardly impressive—after all, some predicted in 1977 that airline deregulation would lead to a United Airlines monopoly. And while we cannot predict all the effects of legal services deregulation, we are confident that those services would be more responsive to consumers and that there would be more jobs in the legal profession.

Authors

Publication: The Wall Street Journal

Image Source: Â© POOL New / Reuters

First Thing We Do, Let's Deregulate All the Lawyers

Robert W. Crandall, Vikram Maheshri and Clifford Winston — Mon, 01 Aug 2011 16:27:00 -0400

Brookings Institution Press 2011 110pp.

Not many Americans think of the legal profession as a monopoly, but it is. Abraham Lincoln, who practiced law for nearly twenty-five years, would likely not have been allowed to practice today. Without a law degree from an American Bar Association–sanctioned institution, a would-be lawyer is allowed to practice law in only a few states. ABA regulations also prevent even licensed lawyers who work for firms that are not owned and managed by lawyers from providing legal services. At the same time, a slate of government policies has increased the demand for lawyers’ services. Basic economics suggests that those entry barriers and restrictions combined with government-induced demand for lawyers will continue to drive the price of legal services even higher.

In First Thing We Do, Let's Deregulate All the Lawyers, Clifford Winston, Robert Crandall, and Vikram Maheshri argue that these increased costs cannot be economically justified. They create significant social costs, hamper innovation, misallocate the nation’s labor resources, and create socially perverse incentives. In the end, attorneys support inefficient policies that preserve and enhance their own wealth, to the detriment of the general population.

To fix this situation, the authors propose a novel solution: deregulation of the legal profession. Lowering the barriers to entry will force lawyers to compete more intensely with each other and to face competition from nonlawyers and firms that are not owned and managed by lawyers. The book provides a much-needed analysis of why legal costs are so high and how they can be reduced without sacrificing the quality of legal services.

Winston and Crandall: The Law Firm Business Model Is Dying, Wall Street Journal, May 29, 2012 By

Read a review of First Thing We Do, Let's Deregulate All the Lawyers in Regulation magazine »

Praise for the book:

"This is a sobering, intelligent, controversial examination of the role lawyers play in the national economy. Although I disagree with some of the authors’ assumptions and conclusions, the brilliance of their analyses cannot be disputed."—Thomas A. Mesereau, Jr., Partner, Mesereau & Yu, LLP, Los Angeles; the lawyer who won the Michael Jackson criminal case

ABOUT THE AUTHORS

Robert W. Crandall

Vikram Maheshri

Vikram Maheshri is an assistant professor at the University of Houston.

Clifford Winston

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Ordering Information:

{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 978-0-8157-2190-1, $19.95 Order
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The U.S. May Need More Lawyers!

Robert W. Crandall and Clifford Winston — Fri, 29 Jul 2011 10:29:00 -0400

Clifford Winston and Robert W. Crandall are co-authors, along with Vikram Maheshri, of the new book First Thing We Do, Let's Deregulate All the Lawyers (2011, Brookings Press).

"The trouble with law is lawyers," famous civil rights lawyer Clarence Darrow once said of his profession.

Lawyers have been derided since the dawn of time, for many reasons. What most people don't realize is that lawyers have cleverly created many restrictions on their industry's size and services through their governing organization, the American Bar Association (ABA).

Thus, the solution to the "trouble with lawyers" is counter-intuitive: we may need more of them -- or, at least, we must spur more competition among them by busting the lawyer monopoly!

ABA occupational licensing requirements have allowed lawyers to create a club with a limited membership that is able to raise prices to consumers, which is how top lawyers can get away with charging upwards of $1000 per hour for their time.

In addition to licensing rules, the ABA accredits law schools, keeping the number of slots available artificially low. In turn, all but a few states today require would-be lawyers to graduate from those ABA-accredited law schools, and all but one state require would-be lawyers to pass the bar exam. In its natural lawyer-like way, the ABA also uses a very loose interpretation of terms to prevent non-lawyers from selling such services as simple, standard-form wills.

It hasn't always been this way. Abraham Lincoln, who neither attended college or law school, practiced law for nearly 25 years, and he turned out to be a good lawyer and a great president. Clarence Darrow also did not graduate from either college or law school, and he is regarded as one of the greatest criminal defense lawyers in American history. But neither Lincoln nor Darrow, nor countless other great legal minds of the past, would likely be allowed to practice today.

While the supply of lawyers has been constrained, the demand for lawyers in the public and private sector has experienced continual growth, thanks in part to government policies that require private firms to retain legal counsel or encourage them to engage in litigation. Many of those policies are drafted and administered by lawyers themselves in Congress and the Executive Branch.

For example, environmental standards governing pollution are determined by teams of lawyers in various administrative agencies and by additional private-sector lawyers. The demand for lawyers to write patent applications and to adjudicate the resulting patent conflicts increased dramatically following the establishment in 1982 of a new U.S. Court of Appeals for intellectual property disputes. State laws, such as consumer protection acts, which in practice have greatly expanded the scope of consumer litigation beyond well-established avenues of consumer protection, have also increased the demand for lawyers. And government policy has done little to stem the excessive growth in the past few decades of liability suits, particularly class-action suits that largely benefit lawyers.

Clearly this supply and demand mismatch has caused wage distortions. With $200 billion spent on lawyers every year in America, the cost to consumers from those inflated prices is in the tens of billions of dollars. Regulations that impede competition and restrict operations have also curtailed potential innovations in legal products and services, such as publications of legal analyses, contracts, and software codes, which could assist middle-income consumers. One firm, LegalZoom.com, which sells simple legal documents like do-it-yourself wills, uncontested divorce documents, patent applications and the like -- documents that should not require pricey lawyers to prepare -- has just been accused of illegally practicing law in the state of Missouri in a class-action lawsuit. Do LegalZoom and firms like it represent more of a threat to consumers or lawyers?

Let's open up the legal field. Non-lawyers and LegalZoom-type companies should be allowed to provide simple services, just as physician's assistants are capable of stitching up a wound so that doctors can focus on more complicated cases. And private corporations that have been prevented from competing with law firms should be allowed to establish their own legal services divisions to offer advice along with, for example, financial and accounting services.

The price of a lawyer can indeed be reduced without sacrificing the quality of legal services. The argument that occupational licensing protects consumers from being harmed by unlicensed practitioners is weak during an era where information is so readily disseminated. A lawyer-specific Angie's List or other places on the internet could easily give consumers information about a practitioner's track record, level of experience, education, and certification, allowing potential customers to quickly and efficiently determine that individual's competence. Instead, today's licensure requirements may create only the perception of quality, thus increasing the demand for credentialed lawyers even in situations where the credential does not add value.

The states could lead the way in a lawyer revolution. A few have already had the audacity to rebuff the ABA and have started to make it easier to enter into the legal services industry. If some states formally eliminate the licensure requirement, and if they express their support for all types of businesses to offer legal services, then the potential benefits to consumers of deregulating lawyers would become transparent and eventually spread nationally. Lawyers themselves, the subject of jabs over millennia -- from the Bible to Shakespeare to Will Rogers -- may even gain from an improved reputation with the public.

Authors

Publication: The Huffington Post

Image Source: Â© POOL New / Reuters

Broadband Creates Jobs

Robert W. Crandall and Hal J. Singer — Tue, 23 Feb 2010 10:29:00 -0500

As the U.S. economy struggles to recover from the worst recession since the 1930s with the unemployment rate hovering around 10 percent, the federal government is understandably focused on policies that could create jobs. At the same time, the Federal Communications Commission (FCC) is putting the final touches on a National Broadband Plan. Unfortunately, few policymakers understand how much the deployment of new telecommunications technologies that underlie the broadband revolution have contributed to employment in the private economy. The National Broadband Plan should be carefully designed so as not to reduce the investment in broadband technologies, which have averaged $30 billion per year since 2005.

During the 2008-09 recession, total private nonresidential capital spending declined by more than 18 percent, but spending by telcos, cable operators, and wireless firms on broadband remained steady, declining by a bare 3 percent. The massive investments made in mobile and wired Internet capacity by the major network providers has sustained hundreds of thousands of jobs over the past six years, and we project that capital investment in broadband over the next few years would create approximately 509,000 jobs relative to a world without such investment.

The impacts of the recent investments in broadband networks have been startling. Because of the intense, facilities-based competition among broadband providers, most U.S. households now have a choice of at least three broadband technologies and even more suppliers in most service areas. That has had the effect of driving down the price and dramatically increasing the speed of broadband access for the average household. It was not that long ago when a high-speed “Ethernet connection” to the Internet was the sole province of government, large corporations, and major academic institutions.

We last examined the economic impact of broadband on the economy and on employment in 2001 and 2003. As it turns out, many of our previous predictions were too pessimistic. We underestimated the growth of broadband – its reach, the applications that it made possible, and the reductions in price of access in the first decade of the 21st century. The increasing availability, improved speed, and lower price of high-speed Internet services that has resulted from the continuing massive investment in broadband infrastructure has had a predictable effect on household subscriptions. The Pew organization’s household surveys show that the share of households subscribing to broadband Internet services has risen from 47 percent in 2007 to nearly 65 percent at the end of 2009, substantially above our 2003 estimate.

The indirect benefits of broadband are perhaps even more significant: Smart young programmers creating new “apps” for smartphones; academic institutions utilizing ever faster broadband to enhance the educational experience; health care personnel being able to deliver world-class medical services to underserved regions domestically and globally; and, businesses being able to order, manufacture, market and distribute their products from anywhere to anywhere. We could not have anticipated many of these developments in 2003; we surely cannot foresee all of the benefits of continuing improvements in broadband services that will occur in the next few years as network companies continue to upgrade their infrastructure.

Despite these impressive benefits, some are proposing that the U.S. radically change course by requiring network providers to share their lines with competitors or by barring network providers from offering differentiated services to content providers. These proposals derive from a debate over the prospective sources of innovation in a world of rapid development of graphics-intensive web pages and new mobile broadband applications. Some argue, without empirical support, that the most important source of innovation will be at the “edge of the network” by content providers. In contrast, there is a clear track record of job and wealth creation associated with investment in broadband access technologies in the network itslef, suggesting that investment at the “core of the network” by network providers is equally, if not more important.

To ensure the steady increase in broadband’s reach, capabilities, and services that we have seen over the past seven years, the FCC should proceed with a minimum of government interference as it moves through the process of creating a National Broadband Policy. To do otherwise would risk a reduction in the incentives for investment in the nation’s broadband infrastructure and the hundreds of thousands of jobs that such investment supports.

Authors

Robert W. Crandall
Hal J. Singer

Publication: The Hill

What About Microeconomics?

Robert W. Crandall and Clifford Winston — Mon, 05 Oct 2009 00:00:00 -0400

In a recent New York Times Magazine article, Paul Krugman laments the current state of macroeconomics (the study of the determinants of an economy's level of output and employment) that blinded us to the forces that, in his view, caused the current recession. However, he never mentions the state of microeconomics.

Microeconomics is the study of how firms and consumers make decisions in markets and how the government tries to address conditions that lead to "bad" decisions. And it has not suffered any serious intellectual setbacks from the current Great Recession. Indeed, the causes and cures of this recession are more about microeconomics than about macroeconomics.

Microeconomists' theoretical and empirical contributions have taught us that market failures do exist but that the government rarely, if ever, can be counted on to correct those failures efficiently. Nothing in the last two years has undermined microeconomic analyses that influenced the deregulation of the airline, trucking, railroad, natural gas, crude oil, telecommunications and cable television markets. These deregulatory successes have not been compromised by the market failures that originated in the financial sector and are at the heart of the Krugman lament. But even if Krugman could uncover a theory that integrates irrational exuberance in financial markets with macroeconomic performance, it would hardly guarantee improved performance of government regulators. Nor would it enhance our considerable knowledge of how markets correct after sharp downturns.

The market failure that generated the current crisis is by now well-known: the rapid growth of subprime mortgages and the failure of many homebuyers and investors to understand and properly weight credit risks. Unfortunately, banks and rating agencies underestimated the probability of a major decline in housing prices and believed that they could measure the interrelatedness of credit risks. Financial firms, consumers and regulators did not adequately account for outliers--very low-probability events--that turned out to be important, leading to a wave of financial institution failures that caused great pain to the real economy.

Read the complete article»

Authors

Publication: Forbes

Detroit Needs a Selloff, Not a Bailout

Robert W. Crandall and Clifford Winston — Thu, 27 Nov 2008 12:00:00 -0500

Congress was decidedly unimpressed by the three domestic auto makers' plea for a bailout last week and responded by asking them to do the impossible: conjure up plans by Dec. 2 detailing how a bailout would revive them.

After more than three decades of denial about their long-term decline, Detroit's car companies must now face the facts. A bailout will not revive them. Moreover, the leading alternative that has been proposed by others -- bankruptcy -- will not re-energize these companies sufficiently to reverse their decline.

In our judgment, based on experience elsewhere in American industry, the most constructive role the government can play at this point is to provide a short-term infusion of capital with strict repayment rules that will essentially require the auto makers to sell off their assets to other, successful companies.

Why is such a dramatic step necessary? For the unavoidable reality that the fundamental problem the auto makers face is not their pension, health-care or other legacy costs. It is that they are not making cars and trucks that enough Americans want to buy. And this has been true to some degree since the first energy shock hit the U.S. in the early 1970s.

In 1970, General Motors, Ford and Chrysler made about 90% of the new cars sold in the U.S. Today their share is closer to 40%. Their market share of light trucks has also declined, but less precipitously thanks to a 25% tariff on many imported light trucks.

How could a federal bailout or a bankruptcy reorganization change that? Pension and health-care liabilities have been a hindrance, but they haven't blocked product innovation.

Bankruptcy has allowed some industries to turn themselves around. A decade ago more than 40% of the steel industry's capacity was reorganized in bankruptcy. The result was the rationalization of capacity and new labor agreements that allowed three large players -- U.S. Steel, Severstal and Mittal -- to create a more efficient steel industry.

But this change occurred only after a dramatic restructuring of the industry in the face of fierce competition from new "minimills." By the time the larger companies -- Bethlehem, LTV, Weirton and others -- collapsed into bankruptcy, they had already shed a vast amount of uneconomic capacity and ceded the production of certain types of products to the minimills.

Thus, the operations that Mittal, U.S. Steel and Severstal bought out of bankruptcy were the most efficient remnants and were devoted principally to making products used in motor vehicles, appliances and (to a lesser extent) construction. They did not have to build new blast or steel furnaces or revamp product lines. They simply had to rewrite labor agreements.

Similarly, the airline industry weathered a round of bankruptcies following 9/11. The problem then was overcapacity relative to what the changing market would bear. But economic recovery and lower labor costs negotiated in bankruptcy allowed most airlines to rebound because they did not have to face multiple carriers that offered better service and cheaper fares.

Detroit faces very different problems. It has had a persistent product-line problem that may be even more severe than its labor problems, and in any event will not be solved by getting UAW wage rates in line with those at the U.S. plants of Toyota, Honda, BMW and Nissan by 2010. The gaps between U.S. and foreign competitors simply have become too large to make up by reducing labor costs or rationalizing capacity. Even if the overall economy rebounds and gives Detroit auto makers some breathing room to emerge from bankruptcy, they will likely face similar -- if not more severe -- problems in the next recession.

In the end, the capital and labor of these companies need to be reallocated into better hands. To this end, we suggest that assistance of some form -- short-term financing or government purchase of equity -- be granted under the condition that the Detroit Three restructure their labor relations so as to be able to sell some or all of their major assets.

There are a number of potential buyers for these assets. Toyota's market cap is $100 billion and Volkswagen's market cap is $110 billion. Either could bid for these assets. Honda, Nissan and even U.S. companies in related sectors, such as Caterpillar or John Deere, are possible buyers.

Members of Congress need to accept that the best possible outcome is a fundamental change in direction for the American automotive industry -- a change that includes making Detroit's facilities more attractive to successful companies. A joint venture between GM and Renault-Nissan was briefly discussed last year, and Daimler-Benz's majority ownership of Chrysler was abandoned this year. Both failed because the Detroit-based operations could not improve their labor relations measurably and otherwise restructure sufficiently to be competitive.

By establishing firm mileposts for asset divestitures from which the companies could repay government funds, taxpayers could be reasonably assured that their money is well spent. But if Congress enacts a bailout without our conditions, the U.S. taxpayer will likely be on the line not only for additional support in the next recession, but likely on a regular basis for the foreseeable future.

We do not generally support government assistance to failing companies. But we think that our proposal will cost taxpayers less and, in the long run, be more beneficial to labor and the overall economy than either a straight bailout or

Authors

Publication: The Wall Street Journal

Transportation and the Economy

Mon, 28 Apr 2008 10:00:00 -0400

Event Information

April 28, 2008
10:00 AM - 12:00 PM EDT

Falk Auditorium
The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

On April 28, the Brookings Institution's Opportunity 08 project hosted U.S. Transportation Secretary Mary Peters for a discussion of America's transportation infrastructure. Secretary Peters focused on the challenges facing the nation’s transportation network, and how local, state and national leaders can take advantage of new technology and approaches to unleash a new wave of transportation investments in this country.

Secretary Peters has more than 20 years of experience in transportation, having served in state government before joining the Bush Administration in 2001. She served as Administrator of the Federal Highway Administration for four years before becoming Transportation Secretary in 2006. In that role she has focused on fighting congestion across all modes of transportation, improving safety and addressing the strains on traditional sources of transportation funding.

Michael O' Hanlon, Senior Fellow and Director of Opportunity 08, provided introductory remarks. A panel discussion featuring Brookings experts Pietro Nivola, Rob Puentes, Robert Crandall, Clifford Winston and Jason Bordoff, followed.

Opportunity 08 aims to help presidential candidates and the public focus on critical issues facing the nation, providing ideas, policy forums and information on a broad range of domestic and foreign policy questions.

Video

Transcript

Transcript (.pdf)

Event Materials

20080428_transportation

Participants

Panelists

Mary Peters

U.S. Transportation Secretary

Jason Bordoff

Policy Director, The Hamilton Project

Airlines are Safer than Ever

Robert W. Crandall and Clifford Winston — Sat, 19 Apr 2008 00:00:00 -0400

Flights on U.S. airlines have never been more crowded – nor have they ever been safer. The last crash of a commercial jet occurred in November 2001, although the number of flights has increased substantially in the past six and one-half years.

Can more effective regulation by the Federal Aviation Administration explain the recent improvement in airline safety? Not according to Rep. James Oberstar (D., Minn.), chairman of the House Transportation Committee. He's expressed concern that a "carrier-favorable, cozy relationship" has set in at the FAA.

Mr. Oberstar formed his view after learning that an FAA supervisor allowed Southwest Airlines to fly planes that had not been inspected in a timely manner for fuselage cracks. Chaos followed: American Airlines cancelled thousands of flights, responding to the FAA demand that it comply with federal rules regarding how certain wires in the wheel wells of MD-80 jets are secured. Of course, American Airlines and other carriers hardly need the FAA to tell them how to operate their $50 million MD-80s safely. Imagine owners of a Rolls Royce relying on a government agency for directives on how to properly maintain their vehicles.

What Mr. Oberstar should have recognized is that the FAA needs a cozy relationship with the airlines. This is because the agency needs to at least give the appearance that it is having a significant impact on safety.

Indeed, the fundamental problem with most regulation is that the regulatory agency does not have sufficient information, flexibility and immunity from political pressure to regulate firms' behavior effectively. Fortunately, the market, and in some cases the liability system, provide sufficient incentives for firms to behave in a socially beneficial manner.

Consider why economic regulation of the U.S. airline industry failed. The Civil Aeronautics Board used to be responsible for regulating fares and the number of carriers serving each route. The CAB used a cost index to set fares between city pairs that, in principle, would enable airlines to earn an above-normal rate of return given the industry's inherent risks, such as unpredictable demand.

But flight frequency was not regulated. Hence carriers offered an excessive number of flights. This reduced the percentage of seats filled by paying passengers, increased average costs, and lowered industry returns. In addition, political pressure from small communities resulted in short-haul fares that were below costs – but were intended to be cross-subsidized by long-haul fares that were above costs. However, because the CAB prevented new competitors from entering regulated routes, air carriers had little incentive to reduce costs.

In a nutshell, the CAB did not have sufficient understanding of industry operations and strategy, the flexibility to facilitate and account for possible changes in industry competition, and immunity from political pressure to set efficient fares. When fares and entry were deregulated, market competition accomplished in large measure what the CAB could not.

Airline safety presents similar problems for the regulator. The FAA knows much less about aircraft technology and airline operations than do the airlines and aircraft manufacturers. In principle, the agency can be educated about such matters, and through consultation with the airlines, aircraft manufactures and expert advisers can develop certain rules and procedures that the airlines agree to follow.

But the airlines will always be far more informed than the FAA is about the condition of their planes. They will also know which procedures and practices are really essential to maintain a comfortable margin of safety. The airlines will be able to make appropriate adjustments to their safety practices – long before the FAA can develop new directives – when information becomes available about aircraft design flaws, appropriate precautions to take when flying in certain weather conditions, and the like.

The FAA may be subject to political pressure to promote the advancement of civil aviation, which may conflict with its mission to promote safety. But the airlines are subject to the unbridled pressure of the market. This pressure put Air Florida out of business following the crash of one of its planes in the Potomac River, and forced ValuJet to emerge as a new carrier, Air Tran, following the crash of one of its planes in the Everglades.

The carriers understand that they cannot attract passengers, employees and investors if they are not vigilant about safety. Consider Southwest – the carrier at the center of this latest "safety" crisis. It has had no passenger fatalities in its entire history. It also has the largest market cap in the U.S. industry, among the best labor relations, and a very high standing with the flying public.

Part of the FAA's mission is to adopt and implement the latest technological advances to expand the airspace where planes can fly safely. How has it done?

In the early 1980s, the FAA announced plans to upgrade the air traffic control system. The fully upgraded system is more than a decade late, billions of dollars over budget, and still nowhere in sight.

Now the FAA is focusing attention on developing a satellite-based air traffic control system – with apparently similar futility. The Government Accountability Office has concluded that the FAA has failed to provide the expertise to make the transition to such a system, and urged it to seek assistance from a third party. We and others believe stronger actions are advisable, actions which would transfer the FAA's responsibility for managing air traffic control to an independent private entity such as Nav Canada, the Canadian air traffic control organization.

Unfortunately, the FAA's inadequacies are shared by other federal agencies that attempt to regulate safety. In our research on the subject, examining available empirical evidence, we could not find any discernible improvement in safety that was associated with regulations promulgated by the Consumer Product Safety Commission, National Highway Traffic and Safety Administration, Occupational Safety and Health Administration, and Mine Safety and Health Administration, among others.

At first blush, the FAA appears to differ from these agencies because its drawbacks do not include stimulating consumers and workers to engage in "offsetting behavior" that compromises efforts to improve safety. Maybe so. But in response to the FAA's overly aggressive actions that caused American Airlines to cancel thousands of flights, many travelers shifted from air travel to highway travel. In the process, they greatly increased their probability of dying in an accident on their journey.

Authors

Publication: The Wall Street Journal

Extending Deregulation

Martha Raddatz and Robert W. Crandall — Wed, 16 Apr 2008 12:00:00 -0400

Few industries remain subject to classic economic regulation in the United States. Senior Fellow Robert Crandall says the next president should help remove some of the controls left on these industries in order to help promote economic expansion.

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Robert W. Crandall

Technical Difficulties

Robert W. Crandall — Thu, 08 Nov 2007 12:00:00 -0500

European investment in high-tech infrastructure has been lagging behind American spending for years now, with direct consequences for the Continent's economy as a whole. Yet next week the EU commissioner for telecoms, Viviane Reding, is expected to announce a radical new policy that will severely hamper future investments in that sector and put Europe even further behind its peers.

The policy that Ms. Reding has been preparing for months now is known as "functional separation." She wants to force owners of the old-line telephone companies to separate their operations into distinct wholesale and retail divisions, with a Chinese wall between the two. This drastic measure is necessary, Ms. Reding claims, because there is an absence of strong competition for the owners of these networks. Allowing new entrants to offer broadband (DSL) service over the incumbents' existing networks will supposedly spur retail competition, since firms won't have to build an entire new network before they can go into business.

There's one huge problem with Ms. Reding's approach. Unlike in the water or natural-gas sectors, telecom networks are not simply unchanging pipes in the ground that require only occasional maintenance. Rather, the typical telecom network is already somewhat obsolete, offering circuit-switched voice services when much lower-cost packet-switched (Internet) telephony is pushing the price of voice calls down to virtually zero. Even broadband and video signals, often haltingly delivered over current telecom networks, are gravitating rapidly to hand-held devices offered by Nokia, RIM or Apple, potentially over a variety of wireless networks.

So network operators must spend billions of euros each year to update their facilities, often replacing assets that were deployed only five or ten years ago. If these carriers are forced to sequester their network assets in separate wholesale divisions, offering access to both rivals and their own retail operations at regulated wholesale rates, their incentives to spend the money needed to modernize these facilities will be substantially reduced.

What's more, it will be difficult for their network managers to make specific investment decisions in this unusual environment, because they will have many retail-service providers who will lobby the regulators over the very design of these networks. This is precisely what happened in the U.S. in the late 1990s when the incumbent telephone operators tried to replace some of their copper-wire facilities with fiber optics. Their downstream competitors used the regulatory process to frustrate these investments, eventually causing the carriers to cancel or severely delay their investment plans until the regulatory policy was changed. This bickering tends to occur because once competitors have adapted to the old network, they become opponents of changes in that network that do not comport with their business plans -- particularly if these changes allow others to offer innovative services that the existing competitors cannot offer to their customers.

The U.K. has led the way here, imposing functional separation on its national carrier, British Telecom, in 2005. Ms. Reding apparently approves of the result. But U.K. broadband subscriptions were already growing more rapidly than the average rate for the EU when the U.K. regulator chose this path. If anything, U.K. broadband growth has slowed slightly since the separation policy was imposed.

If there was a problem in the U.K., it was its dormant cable-television sector, which provided only modest competition for BT in the broadband sphere. The new policy won't stimulate cable competition, and it discourages cable companies from deploying their own broadband services. What's more, it will surely slow U.K. telecom network investment in the next few years. BT is not likely to announce an aggressive roll-out of fiber to homes, emulating Verizon in the U.S. or NTT in Japan. Indeed, there is little interest in such deployments in most of Europe, a disinterest that will only grow if Ms. Reding proceeds with her proposed initiative.

Ms. Reding should investigate the developing literature on high-tech investment and growth. Several studies have shown that in the last few years of the 20th century, the U.S. enjoyed strong productivity growth thanks to its investment in information and computer technology. Recently, Professors Melvyn Fuss (University of Toronto) and Leonard Waverman (London Business School) showed that the EU has suffered a substantial stagnation in productivity growth because it has not invested in these high-tech products and services as intensively as the U.S. or even Australia has.

In fact, Ms. Reding's own office funded a study of EU-15 investment in the communications sector that showed the EU invested far less in 2001-04 in fixed-wire, wireless and cable television infrastructure than did the U.S. in the same period. In 2004, the most recent year for which data are available, EU-15 investment in these sectors was only two-thirds of the U.S. level, even though the EU-15's population is 30% larger than America's. There is no evidence that the EU has begun to close that gap in the last three years, and now Ms. Reding seems hell-bent on expanding it.

There is precedent for the current policy direction in Europe. The U.S. tried to stimulate competition by breaking its national telecommunications company, AT&T, into separate "local" and "long distance" operations in 1984. The experiment worked for a while, but when the network technology had to adjust to wireless competition and the demands of the Internet, the experiment crumbled. The carriers became mired in endless disputes over such questions as whether Internet communications is local or long-distance. The long-distance carriers collapsed despite various attempts by the regulators to save them from the inevitable decline of voice calling rates. By 2005, the telecom sector had become vertically integrated once again, and the structural separation of local and long distance became a distant memory.

Ms. Reding appears unaware of this failure. She even suggested in April of this year that full structural separation may eventually be required of "dominant" telecom carriers. She should ponder whether flourishing competition over isolated and increasingly antiquated telecom networks would serve EU consumers. How much farther behind the U.S., Canada, and Australia should EU high-tech investment be induced to fall?

Authors

Robert W. Crandall

Publication: The Wall Street Journal

Don't Drink the CAFE Kool-Aid

Hal J. Singer and Robert W. Crandall — Thu, 06 Sep 2007 00:00:00 -0400

Several bills are working their way through Congress that would increase the corporate average fuel economy standard (CAFE) for cars and light trucks by 4% per year, reaching a target of 35 miles per gallon by 2018. Aside from economists, whose voices often carry little weight in Washington, there is virtually no opposition to this form of regulation. Not even from a Republican president.

To bolster support for these new rules, CAFE proponents have issued two studies that purport to show that increasing the CAFE standard to 35 miles per gallon would generate fuel savings for car owners in excess of the admittedly higher costs of automobiles; increase carmakers' profits; and generate nearly a quarter of a million U.S. jobs.

A study by the University of Michigan's Transportation Research Institute supports the first two alleged benefits of increasing CAFE, and the third alleged benefit is touted by the Union of Concerned Scientists. Unfortunately, elementary economic principles require one to conclude that the directional change of more stringent CAFE standards on consumer welfare, carmakers' profits, and jobs is exactly the opposite of what these studies suggest.

No one disputes that more stringent CAFE standards would increase the cost of making a car, which would be passed on to buyers. Technologies that improve fuel economy are costly ("there is no free lunch"). Forced to climb to a higher standard, carmakers would embrace the most cost-effective technologies first. But to reach the final rungs on the fuel-economy ladder, carmakers would have to employ very expensive technologies and reduce various aspects of vehicle performance, such as acceleration and vehicle size.

The bone of contention between the carmakers and the regulators (principally the National Highway Traffic Safety Admission) concerns exactly how much those technological improvements would cost in relation to the present discounted value of fuel savings for car owners over the life of the car.

Ask any economist and he'll tell you that estimating the private costs and private benefits of increasing fuel economy is a fool's errand. This is precisely the job of a well-functioning market. For example, if there was fuel-saving technology out there that cost $1,000 but generated $2,500 in the discounted present value of fuel savings over the life of the vehicle, carmakers would surely voluntarily embrace that technology. The carmaker could split the net benefits (equal to the difference between the discounted fuel savings and the cost of the technology) with the car buyer such that both parties to the transaction would be better off.

No need for regulation there. With large numbers of vehicle producers and well-informed consumers, the market is so efficient, in fact, that it ensures that all such transactions will occur, generating the socially optimal level of fuel economy. Markets may generate too little fuel economy if there are social benefits not captured fully by private parties, but CAFE proponents have failed to demonstrate such external benefits. Indeed, external benefits are not even part of their argument.

According to our preliminary estimates, every new GM customer would incur a net loss of several hundred dollars under the newly proposed standard, as the higher cost of the car would exceed the discounted fuel savings. Multiply this loss per vehicle by the number of new vehicles sold and you arrive at annual welfare losses in the billions of dollars.

Regarding the second purported benefit of increasing CAFE, it is naïve to think that carmakers need regulations to increase their profits. As explained above, if a carmaker sees an opportunity to add value for their customers in excess of costs, it will do so. The purpose of regulation is to curb behavior that is profit-maximizing but generates some external cost to society. Thus, regulation typically reduces profits. CAFE proponents seem to have forgotten this basic point.

Finally, the claim that increasing CAFE standards would generate nearly a quarter million U.S. jobs cannot withstand economic scrutiny. First, requiring carmakers to spend more money on cars only diverts resources away from more productive endeavors. No country can expand its wealth by employing people in activities that entail more costs than benefits. Second, the costs of excessive fuel-economy standards are added to the price of the vehicles, inducing consumers to buy fewer new cars, thereby reducing overall vehicle sales. Thus, while carmakers would be spending more to come into compliance with the higher standards, car buyers would be spending less on cars in the aggregate because the newer cars would be more expensive. Demand curves slope down, which means an increase in the price of cars would generate fewer car sales.

Any call for regulation must be based on a market "failure" -- that is, failure of private markets to provide the proper incentives for contributing to social value. In the case of the current call for increases in CAFE, the market failure is generally identified as global warming or national security. But CAFE is a horribly inefficient mechanism for reducing carbon emissions because it does nothing to reduce emissions from power plants, older vehicles, home furnaces or industrial facilities. Nor would it apply to any emissions outside the U.S. Even if one accepts the debatable proposition that less reliance on oil would improve our national security, we should focus our attention on all oil consumption, not just that used in new vehicles. The cost of trying to reduce the harmful external effects of any form of consumption by arbitrarily taxing just 5% of it is extremely costly. A smaller tax on a much wider tax base always reduces the distortions caused by the tax.

When exposed to the piercing light of economic analysis, the alleged benefits of more stringent CAFE standards burn away. Too bad these proposals will not be subjected to economic scrutiny before they become law.

Mr. Crandall is senior fellow in economic studies at the Brookings Institution. Mr. Singer is the president of Criterion Economics. They have advised General Motors on CAFE issues.

Authors

Hal J. Singer
Robert W. Crandall

Publication: The Wall Street Journal

Telecom Time Warp

Hal J. Singer and Robert W. Crandall — Wed, 11 Jul 2007 00:00:00 -0400

Calls for non-discrimination rules in telecom arise periodically from disadvantaged groups of rivals. In the late 1960s, the call for regulation came from equipment providers; in the early 1980s, it came from long-distance providers. In the mid-1990s, it was local exchange carriers and Internet service providers. Today Internet telephone, or "VoIP," providers want help, but to obfuscate their role, they couch it in a deceptive, overused phrase: "network neutrality."

Unfortunately, some lawmakers and regulators are seriously entertaining these pleas for greater regulation. The FCC is considering service rules for the upcoming 700 MHz-auction sponsored by Frontline, a firm headed by former FCC chairman Reed Hundt, which would impose, among other onerous requirements, a net neutrality requirement on the winning bidder. And today Rep. Edward Markey (D., Mass.), chairman of the House Subcommittee on Telecommunications and the Internet, will hold a hearing on the subject of "wireless net neutrality."

When the government decided to impose nondiscrimination rules on (the old) AT&T in the late 1960s, AT&T and its local operating companies controlled virtually the entire telecommunications sector. There were no local competitors, no cable companies offering phone service, not even any wireless companies. AT&T was also vertically integrated into the manufacture of telephone equipment through its ownership of Western Electric. Before its breakup, AT&T had both the incentive (due to its vertical integration) and the ability (due to its market power in voice service) to engage in anticompetitive conduct in complementary markets (equipment).

The telecom environment could not be more different today. There are three survivors of the breakup of AT&T's fixed-wire business, each of which offers phone and high-speed Internet service and is spending billions of dollars upgrading its network to offer video services. Cable television companies have also upgraded their networks so they can offer these services. And the five largest wireless carriers -- AT&T, Verizon, Sprint, T-Mobile and Alltel -- are also spending heavily so that they can offer high-speed Internet connectivity.

Meanwhile, a cable industry consortium last year spent more than $2 billion in a national wireless auction just to acquire the spectrum real estate that would allow it to become the nation's sixth carrier offering nationwide wireless phone service. Not to be left out, Craig McCaw and Intel are building a national fixed wireless network, and Wild Blue is offering a competitive service from an innovative satellite launched last year.

What is the likely impetus for all of this new investment? In 2004, the federal courts required the FCC to relax its strict regulation of the Bell companies in part because of its depressing effect on the Bells' investment spending. And, unlike their European counterparts, U.S. wireless operators have been essentially unregulated since 1993. As a result, U.S. telecom capital spending is surging as various competitors are now moving aggressively to provide high-speed Internet services to consumers who want to receive more than email over a variety of different devices.

To some in Washington, the explosion of investment and entry is interpreted with skepticism and hand-wringing. These worrywarts are pressing for a new regulatory regime of "network neutrality." This would prevent fixed-wire broadband networks from charging content suppliers, such as Google or YouTube, for priority delivery of their services to consumers, much as FedEx routinely does for packages. It would also prevent these operators from building intelligence into their networks, and instead would require them to meet the coming demand for bandwidth-intensive applications solely with fatter, dumber pipes. Such a policy would surely increase the cost of building next-generation, high-speed networks, which in turn would delay investment and increase the price of Internet service.

More recently, the cry for network neutrality has spread to the wireless sector. Proponents of "wireless net neutrality" seek to prevent wireless operators from imposing limitations on certain bandwidth-intensive applications available over their networks. In particular, the Internet telephony (VoIP) companies, such as Skype and Vonage, want regulators to force the wireless companies to allow their subscribers to access these VoIP services through unlimited data plans, thereby allowing subscribers to completely bypass the wireless network owners' voice services. This proposal has been developed by Columbia law professor Timothy Wu.

Mr. Wu and his confreres ignore the fact that no U.S. wireless carrier has market power. In fact, competition in this sector is so intense that according to FCC data, the price of a wireless call has declined from $0.43 per minute in 1995 to $0.07 in 2005 -- roughly 84% in one decade.

This price decline is a function of the number of options facing wireless customers. The lack of market power for any individual carrier makes price reductions irresistible and any anticompetitive practices unsustainable. If consumers were to find that access to VoIP or any other application would increase the value of their wireless experience, surely one or more of the wireless carriers would find it profitable to offer such a service on their own, but not at a loss. If they were forced to allow the VoIP companies such as Skype or Vonage to bid away their own traditional voice revenues, the wireless carriers would simply raise the price of the data services over which Skype or Vonage would be delivered. The obvious losers from such a policy would be the subscribers who rely upon these high-speed data services for other purposes, such as email or Web browsing.

Like wireline operators, wireless operators generally perceive content innovation to be a good thing: The demand for killer applications will drive the demand for faster (and more expensive) broadband connections. Nevertheless, even competitive wireless operators may at first resist offering a service, such as Internet telephony, because it reduces the revenues that they earn from traditional voice services.

But even if all wireless carriers were to decide to block VoIP services on their networks for the foreseeable future, regulators should take a hands-off approach for a number of reasons.

First, the provision of VoIP over other (wireline) platforms provides an outlet for VoIP providers to achieve the requisite economies of scale. Second, the dramatic decline in wireless prices continues with or without VoIP, and the coming entry of the cable companies into wireless services will only accelerate this decline. Third, regulators cannot require wireless networks to allow new Internet voice services to cannibalize the wireless carriers' principal source of revenues without inducing the wireless companies to recover their network costs from other charges to their subscribers. There is no free lunch here -- networks cost money to build and operate.

Thus, even in the single application in which wireless network owners could be said to compete with unaffiliated upstream suppliers, there is no need for regulation. When viewed in this light, network neutrality regulation should be more aptly named: "Life Support for stand-alone VoIP Providers" who are struggling to compete in a world of declining prices and bundled service packages.

With respect to every other conceivable application, regulation would be completely unnecessary, as wireless network owners lack both the incentive and the ability to engage in discriminatory practices because they have no market power.

The lesson for future content providers -- particularly those now seeking network neutrality regulation -- is that they should develop content that network owners will perceive as being complementary to their offerings and therefore will add value for their broadband customers. Ignoring this advice will work only as long as the regulators are under the content providers' thumb.

This is the strategy that Apple's and Microsoft's rivals are using in Europe, with little apparent success. It is even less likely to work on this side of the Atlantic, where the regulatory winds that blow in and out of Washington are constantly changing. Eventually, either the FCC or the courts will realize that regulating competitive networks for the benefit of select content providers is not in the interest of American consumers.

Authors

Hal J. Singer
Robert W. Crandall

Publication: The Wall Street Journal

The Effects of Broadband Deployment on Output and Employment: A Cross-sectional Analysis of U.S. Data

Robert W. Crandall, William Lehr and Robert E. Litan — Fri, 01 Jun 2007 12:00:00 -0400

High-speed internet access has developed rapidly in the last decade and is increasingly viewed as essential infrastructure for our global information economy. For example, as recently as mid-2000 there were only 4.1 million broadband lines in the United States and only 3.2 million of these were residential lines. Thus, in mid-2000 less than one household in thirty could access the internet at a download speed of 200 kbps or greater. Six years later, the number of broadband lines, excluding mobile wireless connections, had soared to more than 53.5 million, 49 million of which were in residences. Residential penetration had therefore risen to nearly 50 percent by the middle of last year. (If mobile wireless connections are included, total U.S. broadband lines had risen to more than 64.6 million lines.)

While most communications sector analysts concur that the ability to deliver broadband communications is a critical feature of the modern global communications infrastructure, there is limited recent empirical research on the economic effects of broadband. In particular, much of the available research is now several years old or refers to the benefits of the Internet generally or more broadly of the "digital economy" rather than to the broadband telecommunications infrastructure per se.

This study provides new estimates of the effects of broadband penetration on both output and employment, in the aggregate and by sector, using state level data. We estimate these benefits by using FCC data on broadband penetration for the lower 48 states over the 2003-05 period, controlling for a variety of other factors that also could account for the growth in output and employment during this time. Although the FCC's definition of broadband is broader than we would like - since it includes all connections of 200 Kbps and faster at a time when broadband speeds are routinely greater than 1 Mbps - the FCC penetration data are the most comprehensive and reliable source of such information currently available.

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Extending Deregulation: Make the U.S. Economy More Efficient

Robert W. Crandall — Wed, 28 Feb 2007 00:00:00 -0500

Thirty years after passage of the Airline Deregulation Act, the U.S. airline industry is still adjusting. There's been a lot of upheaval lately. Aloha and ATA Airlines are out of business and Frontier is in bankruptcy. Delta and Northwest are working on a merger; Continental and United are each looking for a merger.

Up on the Hill, Sen. Daniel Inouye says he plans to conduct Senate hearings to examine re-regulation. Not so fast, says Robert Crandall. He says deregulation has led to significant consumer savings and safety and that the next president should continue to promote deregulation and to open up the domestic market to allow foreign carriers to compete.

Recommendations
To help remove some of the last vestiges of such controls, the next President should:

promote full deregulation of all voice telephone services
oppose "network neutrality" initiatives for broadband telecommunications that would interfere with pricing innovations designed to relieve network congestion
within the electricity sector, support market reforms (such as real-time pricing) and incentives for expanding or preventing overloads in transmission grids and distribution networks and allow states to proceed at a measured pace in deregulating electrical generation
promote competition among airports and privatization of air traffic control in order to improve the pricing of airport landing rights and reduce air traffic congestion
back "open skies" or "cabotage" approaches to international air travel and allow more foreign investment in domestic airlines

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Opportunity 08 aims to help 2008 presidential candidates and the public focus on critical issues facing the nation, presenting policy ideas on a wide array of domestic and foreign policy questions. The project is committed to providing both independent policy solutions and background material on issues of concern to voters.

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Robert W. Crandall

Publication: Opportunity 08

Unfriendly Skies

Clifford Winston and Robert W. Crandall — Mon, 18 Dec 2006 00:00:00 -0500

Almost on cue, members of Congress have responded to US Airways' interest in acquiring Delta Air Lines, and a possible deal between United Airlines and Continental Airlines, with predictions that fares will rise, service will be reduced, and more mergers will surely follow. Not to appear soft on threats to competition, the Justice Department has expressed its concern that the proposed mergers raise antitrust concerns and has vowed to conduct thorough investigations.

Mergers may harm consumers if they are the route to (or the root of) market power and ultimately allow the combined firm to increase consumer prices and reduce service. In such cases, enforcement of the antitrust laws could improve consumer welfare by blocking the mergers before they occur and by discouraging future harmful mergers. But our research suggests that government efforts to address such threats do little to improve consumer welfare and sometimes actually reduce it. More importantly, government often misses fruitful opportunities to benefit consumers because it eschews market-oriented policies.

The empirical evidence on the main factors that influence airlines to merge their operations does not suggest that these mergers are driven by a desire to obtain market power. In a 2000 paper, Steven Morrison and Clifford Winston analyzed the determinants of all the actual and attempted airline mergers since the 1978 deregulation. They found that carriers are generally not motivated to merge for anticompetitive reasons, but rather by the acquiring carriers' desire to expand their international routes -- which are far more profitable than most domestic routes due to government-to-government agreements that limit entry -- and by the acquired carriers' need to be rescued from financial distress.

Clearly, gaining access to additional international routes is an important consideration in the two mergers under discussion. US Airways would gain from having access to international routes currently served by Delta, and United and Continental could gain from expanding their portfolio of international routes. Because Delta is in the process of emerging from bankruptcy, it appears to have solved its financial problems on its own and is therefore not enthusiastic about a merger with US Airways.

What about evidence on the effects of previous mergers on travelers? In the aforementioned paper, the authors found that the USAir-Piedmont merger and the Northwest-Republic and TWA-Ozark mergers, which were opposed by the Justice Department but approved by the U.S. Department of Transportation (at the time DOT had jurisdiction in the matter), had benign effects on fares while increasing travelers' accumulation of frequent flier miles.

Today's airline industry has become very competitive because of the expansion of low-cost carriers such as Southwest, JetBlue and AirTran, whose combined market share currently approaches one-third of the domestic market. Any potential anticompetitive effects of a US Airways-Delta merger or a United-Continental merger would be quickly tempered by the responses of these low-cost carriers. The larger "legacy" (pre-deregulation) carriers now face competition from low-cost carriers on nearly three-quarters of their domestic routes. Low cost carriers have expanded their presence even to such markets as Philadelphia and Pittsburgh that had traditionally been dominated by legacy carriers, and they are poised to provide additional capacity in any markets that are adversely affected by any of the proposed mergers. Low-cost carriers can and do move very quickly to mitigate any increase in fares initiated by the legacy carriers — whether caused by a merger or simply by unilateral action.

Ultimately, the effect on travelers of changes in airline market structure caused by mergers or other forces depends on the specific carriers that exit a market and the specific carriers that take their place. For example, a recent study found that in the year 2000 travelers would have been $20 billion worse off due to higher fares and less frequent service if Southwest Airlines did not exist at all. In contrast, consumers would actually have been better off during that year if US Airways had left the industry because more efficient carriers, such as Southwest, would have entered its routes. Because any initial contraction in service and increase in fares by merged legacy carriers is likely to attract entry by low-cost carriers, fares would quickly decline to or possibly below pre-merger levels and return service frequency to or possibly above pre-merger levels. Trustbusters would be prudent if they simply exercised a reasonable degree of patience in the wake of such combinations.

Rather than attempt to combat airline mergers, government policy makers could have a much more beneficial impact on the welfare of air travelers by pursuing policies that increase competition on international and domestic routes. With one swift stroke, deregulation of international markets would eliminate a major motivation for many of the mergers. The U.S. government has been negotiating so-called "Open Skies" agreements with other countries for several years, but negotiations have invariably stalled for a variety of reasons. One issue is the government-mandated limit on foreign ownership of U.S. carriers, currently capped at 49%. Ending any limits on foreign ownership would also make it easier for struggling U.S. carriers to attract foreign capital to help solve their financial problems and possibly eliminate another major reason that carriers seek a merger.

Allowing foreign carriers to serve U.S. domestic routes (cabotage) would provide another source of competition that would benefit air travelers. Think of how foreign transplants have transformed the automobile and steel industries to the benefit of consumers. Sir Richard Branson has expressed an interest in starting up a Virgin Airways operation in the U.S. but faces ownership issues, among other obstacles.

Still another way that policy makers could potentially stimulate airline competition is to privatize U.S. airports, thereby allowing them to compete aggressively for air carrier service. Competitive entry at some airports is constrained by insufficient gates and terminal space. Given the contractual relationship governing publicly owned airports and the incumbent airlines that help pay their bonds, some airports have limited incentives to attract additional carriers.

Federal policy makers' attempts to correct market failures, such as those deriving from monopoly power, have in practice frequently been an abject failure, and missed opportunities to improve market performance. The latest round of proposed airline mergers illustrates the problem: Policy makers will undoubtedly find it politically expedient to use the antitrust laws in an inappropriate manner, instead of standing up to the entrenched interests who oppose changes in current government policies that would have a far more beneficial impact on competition in the airline industry.

Authors

Publication: The Wall Street Journal

Regulating Emissions of Greenhouse Gases Under Section 202(a) of the Clean Air Act

Sun, 01 Oct 2006 00:00:00 -0400

The authors consider whether the Environmental Protection Agency's denial of the petition to regulate emissions of greenhouse gases from motor vehicles under Section 202(a) of the Clean Air Act was reasonable in light of the global nature of greenhouse gas emissions and the likely superiority of other methods for combating greenhouse gases.

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Authors

Paul L. Joskow
Richard L. Schmalensee
Robert W. Crandall
Robert Hahn
Robert E. Litan
William J. Baumol

Publication: AEI-Brookings Joint Center Policy Brief

The AT&T/BellSouth Merger: The Breakdown of 'Breakup'

Clifford Winston and Robert W. Crandall — Thu, 09 Mar 2006 00:00:00 -0500

This week's stunning announcement by AT&T that it had reached an agreement to acquire BellSouth for $67 billion is surely an affront to proponents of a strong antitrust policy for two reasons. First, it looks like a big step toward putting Ma Bell back together 22 years after the trustbusters' biggest victory since the breakup of Standard Oil in 1911. Second, they know that the antitrust authorities will find it very difficult to derail this merger because it poses no threat whatsoever to the vitality of competition in the communications sector.

The AT&T/BellSouth merger is simply the latest indication of the irrelevance of antitrust in a rapidly changing global competitive environment. In telecommunications, the changes in competition have come from an explosion in technology and at least partial freedom from the suffocating embrace of government regulation. In other sectors, the growth in the global economy and world trade has made it increasingly difficult to find examples of firms with sustainable market power. What firm in the motor vehicles, chemicals, banking, primary metals or energy business could be said to have the power to affect price by restricting its own output? Moreover, we can now think the unthinkable: Would consumer welfare seriously be threatened if Ford and General Motors merged? What about a merger of U.S. Steel and Mittal Steel? As long as international borders are open, competition flourishes even without an antitrust authority.

The dearth of demonstrable benefits from antitrust policy in recent years underscores the problem. Consider the Justice Department's monopolization case against Microsoft, which ended with a remedy that left both sides wondering, "What was the point?" The case continues in Europe where trustbusters are pressuring Microsoft to unbundle its Media Player software from its PC operating system. Meanwhile, Steve Jobs's bank account grows while his iPod technology shows how impotent Microsoft is in the music/video business. It is our experience that when a U.S. proponent of antitrust is pressed to suggest an example of the policy's success, he will not point to Microsoft, but to — you guessed it — the breakup of AT&T.

The AT&T case is an important political prop in the current support for antitrust because, as we have shown in a 2003 Journal of Economic Perspectives article, there is a paucity of empirical evidence that more than a century of antitrust enforcement has provided benefits to U.S. consumers. Yes, there are the "what about . . ." responses, such as the successful attack on the electrical equipment price-fixing conspiracy in the 1960s, the prosecution of a 1990s international vitamins cartel and even some uninformed comments on the "success" of breaking up Standard Oil after John D. Rockefeller had retired and new discoveries of oil had greatly reduced the market power of the company he had founded. But no one has yet pointed to a serious academic study that shows that antitrust has led to lower prices, greater output or increased technological progress.

To the contrary, one of the few systematic investigations into the effects of price-fixing conspiracies showed that prices generally rose after a successful government prosecution of a conspiracy under Section 1 of the Sherman Act. Nor is there evidence that the government's assault on monopolization under Section 2 of the Sherman Act has been successful. We have found no evidence that successful prosecutions of Standard Oil (1911), American Tobacco (1911), Alcoa (1945), the movie companies (1948) and United Shoe Machinery (1954) have led to lower prices or greater output in the industries in which they operated.

Finally, the antitrust authorities have had a poor recent track record in the federal courts when merger participants challenge their attempt to block a merger under the Clayton Act. The DOJ still feels the sting of a 2004 federal court denial of its attempt to block the Oracle/People Soft merger. It is highly doubtful that justice would improve its record with a legal assault on the AT&T/BellSouth merger.

AT&T and BellSouth offer conventional telephone service in different regions of the country. AT&T (formerly called "Southwestern Bell") operates in the Southwest, Far West and the Midwest. BellSouth provides telephone service in the Southeast. Both companies are losing subscriber lines rather rapidly as consumers switch to cellular phones or "voice over Internet protocol" (VOIP) provided by the cable companies or independent providers, such as Vonage. The new broadband (DSL) Internet services offered by these erstwhile phone titans have not been sufficient to offset the revenue losses from traditional telephone services. All old-line telephone companies are now desperately trying to enter the video market in their own regions so that they can begin to show modest growth once again. Combining these two companies may provide some useful synergies in their battle to compete with the cable television companies, but one would have to employ a fanciful argument to conclude that the merger gives them measurable power to raise the price of phone service, DSL or video services.

AT&T and BellSouth jointly own Cingular, the largest of the four national cellular carriers. Although the merger may solidify AT&T's control over Cingular because it raises its interest in ownership from 60% to 100%, it surely does not provide AT&T with any power to raise cellphone rates. Verizon Wireless, Sprint and T-Mobile will continue to compete with Cingular, as before.

Like many episodes in antitrust, the matter at hand has emerged while industry competition is undergoing significant and unpredictable changes. Cable companies are invading the old-line telephone companies' core telephone business while retaining more than half of the new broadband Internet business. Cellular carriers are beginning to offer high-speed Internet connections and are even launching video services over cellphones. Satellites with directed "spot beams" will soon be able to offer high-speed Internet service. Google has announced its intention to deploy a fixed wireless WiFi service throughout San Francisco. Might Yahoo, Microsoft or Apple begin to consider similar moves? Most of us now make our long-distance calls at zero prices on evenings or weekends over our cellphones, or we simply rely on email and Instant Messenger.

In the midst of such upheavals, government antitrust "victories" have proven to be illusory precisely because the trustbusters could not anticipate how the markets involved were changing. It will be extremely difficult for anyone to argue with much credibility before a federal judge how the AT&T/Bell South merger will affect the prices and output of telecom or video services for the foreseeable future.

Antitrust proponents might then be reduced to arguing that the merger is clearly a backward step in the face of benefits to consumers from breaking up AT&T in 1984. However, telephone rates are no lower in the United States than in most other developed countries, which wisely decided that they should not break up their national telephone companies and suffer through two decades of legal and regulatory hell that offers little improvement in competition. Appearing to put Ma Bell back together again may embarrass the trustbusters, but it should not concern American consumers who, in two decades since the breakup, are overwhelmed with competitive options to provide whatever communications services they desire.

Authors

Publication: The Wall Street Journal

Auto Industry on the Line as it Juggles Efficiency, Profits

Robert W. Crandall and Clifford Winston — Mon, 23 May 2005 00:00:00 -0400

The recent downgrade of Ford's and General Motors' long-term debt was but the latest in a series of public indications that the once-dominant U.S. motor-vehicle companies have failed to turn their operations around since signs of weakness surfaced in the 1970s. For decades, the U.S. manufacturers have been able to rely on government protection and robust economic growth to mask their fundamental problem: American consumers increasingly believe that other companies produce better vehicles -- cars and light trucks -- for the money.

As the Japanese and European automakers expand their production facilities in the United States and Canada, trade protection can no longer shield the U.S. producers from this unpleasant reality. U.S. government policymakers can do little to help them, and as a result DaimlerChrysler, Ford and GM may find that even a strong economy is not sufficient to keep them profitable.

Thirty years ago, the Japanese automobile companies were just beginning to make inroads in the U.S. market. The high gasoline prices caused by the first OPEC oil imbroglios led American consumers to look seriously at the small, fuel-efficient Japanese cars for the first time. What they saw was not only fuel efficiency but reliability. Japanese cars, even in the 1970s, would have fewer repair problems than their American-produced counterparts. As a result, even after oil prices began to fall, Japanese car imports continued to grow. By the early 1980s, the U.S. companies were experiencing financial distress and turned to the government. The Reagan administration was persuaded to negotiate "voluntary export restraints" with the Japanese producers, limiting their shipments of cars to the United States.

Did government intervention give the Big Three time to improve their vehicles or did it just protect them from foreign competition? When the trade restrictions were imposed on the Japanese companies, the 1985 models were just being introduced. In April 1985, Consumer Reports' annual auto issue showed that the probability that U.S. consumers who purchased cars produced over the last six years by the U.S. producers would experience "worse than average" or "much worse than average" repair problems was six times as great as that probability for Japanese cars purchased by U.S. consumers. Twenty years later, this year's Consumer Reports shows precious little narrowing of the U.S.-Japanese reliability gap as U.S. cars are still five times more likely than Japanese cars to show serious repair problems.

Despite the problems with the relative quality of their vehicles, the U.S. automakers were able to withstand the competition from the Japanese firms, largely because of the strong U.S. economy since 1985, relatively low gas prices, and a shift in consumer preferences to SUVs, vans and pickup trucks that happened to be shielded from foreign competition because the United States has had a 25% tariff on light trucks since the 1960s. Moreover, the Japanese companies were not particularly adroit in developing light trucks because their home market consumers had little interest in them. In the last few years, however, the Japanese producers have begun to develop highly competitive trucks, vans and SUVs, and they now produce them in the United States, thereby avoiding the 25% duty. Thus, even this niche is no longer a safe haven for the U.S. companies.

Today, Toyota sells about 2 million vehicles in North America and produces 1.3 million of them in the United States and Canada. Honda produces 1.2 million vehicles in the United States and Canada, about 80% of its North American sales, and Nissan produces about 800,000 vehicles in the United States out of the 1 million vehicles it sells in the United States per year. Subaru, Mitsubishi and Mazda also have significant production capacity in the United States. The Europeans and Koreans, though less threatening than the Japanese, have also expanded their share of the U.S. market over the last 20 years and have begun to build plants in the United States.

American producers now account for only about 56% of U.S. vehicle sales, and their share is falling steadily. Within the next three or four years, it is possible that foreign companies will produce and sell more vehicles in the United States and Canada than the American companies do, a result that surely would have been viewed as inconceivable when the Japanese export restraints were negotiated 20 years ago.

If the Japanese and Europeans can produce high-quality vehicles, many in the United States, and can do so profitably, why are the U.S. companies struggling? In a recent paper, one of us found that the U.S. manufacturers' loss in market share over the past decade can be explained almost entirely by changes in basic vehicle attributes: price, size, power, operating cost and body type. That is, while the U.S. manufacturers have improved their vehicles along these lines, they have not narrowed the gap with the Japanese and European manufacturers. This finding suggests that the American firms face serious problems in product design, engineering and management-labor relations that they simply have not been able to solve.

Detroit cannot look to Washington to mask these problems. In 1984, the federal government could slow the imports of cars from Japan. Today, it cannot slow the imports of Japanese or European cars and trucks from Kentucky, Ohio, Tennessee or Alabama into the rest of the country without a constitutional amendment to repeal the Commerce Clause.

The federal government tried to help by subsidizing development of new fuel-savings technologies, but this project came up empty when the U.S. companies used the money on trying -- thus far unsuccessfully -- to develop electric cars and fuel cells while the unsubsidized Japanese companies developed hybrid vehicles.

Whatever the government does to reform health care may help the U.S. companies, but it will also benefit the Japanese companies who now use American labor to produce most of the vehicles they sell here.

Obviously, a strong economy will help the U.S. companies' balance sheets even as their market share continues to decline. But the U.S. automakers certainly cannot hope to remain profitable by continuing to lose market share, and the U.S. government is out of options to help them.

Authors

Publication: Detroit Free Press