THE COMPETITIVE TRANSFORMATION of local exchange telecommunications and the electric power industry raises significant questions about whether regulators should give a public utility the opportunity to recover its stranded costs. As regulators mandate the unbundling of basic network elements in local telephony or wholesale and retail wheeling in the electricity industry, they introduce competitive rules that potentially deny incumbent utilities the opportunity to recover the cost of service. While competition presents incumbents with opportunities to serve customers in new ways, regulators often leave untouched the utility's preexisting incumbent burdens. Such regulatory action threatens to confiscate private property—shareholder value—for the promotion of competition, without just compensation. This chapter addresses the major issues giving rise to the problem of deregulatory takings.

To understand deregulation, it is necessary to identify a number of important economic issues and define essential concepts. Why were the network industries regulated in the first place? What motivated policymakers to undertake deregulation? Although it is not possible to review here all of the social, political, and market forces that motivated the creation and reform of regulation, it is useful to examine some of the key economic arguments for both the creation and the removal of regulation.

NATURAL MONOPOLY AND NETWORK INDUSTRIES

The presence of natural monopoly technology provides a central motivation for establishing regulated industries and accordingly imposing entry barriers, price controls, and obligations to serve. As then Professor, now Justice, Stephen G. Breyer observed, “The most traditional and persistent rationale for governmental regulation of a firm's prices and profits is the existence of a ‘natural monopoly.’”