How can regulators set nonarbitrary interim rates? The case of local loop unbundling in Ireland

During a period of substantial regulatory change, as in the case of network unbundling in telecommunications, regulators often face the challenge of setting ``interim'' rates for services. How, in the face of inherently imperfect information and the need to proceed according to what is invariably an expeditious plan of deregulation or industry restructuring, can the regulator select an interim rate that is the least arbitrary? In this Article, we answer that questions using, as a case study, local loop unbundling (LLU) in the Republic of Ireland in 2001. We analyze the interim prices set by the Office of the Director of Telecommunications Regulation (ODTR) for access by competitors to the local network of the incumbent carrier, eircom. The ODTR's interim prices are based on a simple average of the prices in ten European Union countries for the same service. That methodology is flawed because, with minimal effort, the regulator could have used publicly available data to produce a considerably less arbitrary interim rate. A simple average does not produce good in-sample predictions when the sample variance is large relative to the sample mean – as is the case with the prices of unbundled loops in the EU countries. Using a simple multiple regression model, we find that the ODTR's methodology ignores relevant information, such as population, wage rate, population density, and the degree of urbanization, which, in a sample of the fifty U.S. states and ten European countries, explains roughly 25 percent of the cross-sectional variation in unbundled loop prices over and above that which can be explained by the sample mean alone. The regression model would produce an interim rate that is 42 percent higher than the rate set by the ODTR. Finally, we observe that interim rates that impose artificially low pricing of unbundled network elements will discourage facilities-based investment, to the long-run detriment of consumers.