Legal rules as a source of comparative advantage: A case study of telecommunication equipment interconnection

Legal rules governing the interconnection of customer-premises equipment (CPE) to the telephone network have economic implications for both producers and users of such equipment. The United States instituted a free-interconnection policy between 1968 and 1976; Canada, Japan, and the United Kingdom adopted similar policies in the 1980s. A free-interconnection policy can impose costs on domestic producers as a result of increased competition among both foreign and domestic producers, but it can also provide benefits to domestic users who gain access to the world market in CPE. Interconnection rules can therefore provide a comparative advantage to countries that adopt the most favorable policy.

It is shown here that free interconnection has been a favorable policy for the United States. Costs to domestic CPE producers have been small, and benefits to large users appear to have been large, both in terms of increased product diversity and in terms of price and quality of established products. The movement toward free interconnection in other countries appears to be based on the favorable experience in the countries that have already made this change.

This CPE example suggests a generalization that can be expressed in terms of the “market for regulation” concept. It is suggested that an equilibrium in this market occurs at the point of maximum benefits minus costs, as experienced by the participants in this market. This equilibrium is a “rule equilibrium.” In the case of CPE, the old equilibrium was at the no interconnection point while the new equilibrium is at the free interconnection point toward which the world is presently moving.