Technical efficiency,allocative efficiency,and the impact of incentive regulation in telecommunications in the United States

Incentive regulation is now an important regulatory tool in the telecommunications industry in the United States. The objective of incentive regulation is to improve productive efficiency, enhance service quality and consumer welfare, and reduce the costs of regulation. The issue that is considered here is whether incentive regulation in the form of a price cap applicable to interstate access service to local loops has resulted in an increase in the technical efficiency and allocative efficiency of local exchange carriers (LECs). After discussing the reasons for adopting incentive regulation, the nature of price caps is explored followed by an overview of the methodology for measuring the effects of incentive regulation on productive efficiency. The results indicate that for changes in technical efficiency, there is a definite randomness between 1985 and 1993 with technical efficiency increasing in some years and decreasing in others. Subsequent to 1993, however, there is a consistent improvement in technical efficiency. Given that incentive regulation in the forin of price caps was implemented for LECs in 1991, it is likely that some portion of the improvement in technical efficiency subsequent to 1993 is attributable to incentive regulation. A pronounced upward trend in allocative efficiency is observed beginning in 1985. It is problematic, however, to attribute the improvement in allocative efficiency to the adoption of incentive regulation. It is more likely an artifact of the divestiture of AT&T although some indeterminant portion is probably associated with the implementation of price caps.JEL classification: L51, L96