Abstracts Economics

Cost structure of the local telecommunications industry

by Olesya Gainutdinova

Using a panel data set on the local telecommunications companies reporting to the FCC for 1988-95, this paper investigates the subadditivity of the cost function, as well as technical and allocative inefficiency of the U.S. local telephone industry. The subadditivity test on the estimated translog cost function indicates that certain subdivisions of the monopolized regional markets between two hypothetical firms might lower total cost. However, the evidence is not as clear cut as in an earlier study by Shin and Ying (1992, RAND), with savings from a two-firm industry being negative on average over all possible two-firm output vector combinations. The results of the subadditivity test suggest that companies with a relatively high share of residential customers experience higher degrees of scale inefficiency. Specification of technical inefficiency as fixed company-specific effects results in a different efficiency ranking than the specification with random effects. The estimation results for the generalized (non-minimum) cost model suggest that capital is being under-employed relative to residual inputs. This finding does not support the theoretical prediction that an industry under rate of return regulation tends to over-employ capital relative to other inputs. The subadditivity test for the generalized cost function that accounts for technical and allocative inefficiency generated a much more favorable estimates of cost reductions from the subdivision of the monopolized markets than the test on the conventional specification of the cost function. The estimated losses from technical, allocative and scale inefficiency reflect potential gains from competition.