The impact of non-neutral federal regulatory policy on competition

• Federal regulatory policies abound in the telecommunications industry.
• The Universal Service Fund aims to ensure telecommunications access to all.
• Carrier of last resort policies require firms to serve high-cost geographic areas.
• Simultaneous implementation of policies can adversely affect competition.
• Unintended consequences of complementary policies can reduce consumer welfare.

We present a duopoly competition model to illustrate how the simultaneous incorporation of two US federal regulatory programs negatively affected telecommunications competition during the past decade. Our model shows that the simultaneous implementation of the Universal Service Fund policy that grants subsidies to incumbent telecommunications providers serving in high-cost areas, and the carrier of last resort policy that mandates incumbents to provide service in under-served geographic areas, deters competitive entry in low-cost markets and thereby runs counter to the objectives for which the policies were intended. This model provides a theoretical explanation of a failure of federal policy.