Assessing the Effect of Incentive Regulation on Productive Efficiency in Telecommunications in the United States

The use of incentive regulation in telecommunications in the United States requires accurate measurement of the change in productivity. An approach to measuring productivity change, the Malmquist index approach, is introduced that not only provides a measure of that change but also allows for a decomposition into two mutually exclusive and exhaustive components—changes in technical efficiency over time and shifts in technology over time. Using annual data on four output measures and six input measures for the period 1988 to 1999 for nineteen local exchange carriers, the results indicate that productivity increased by about 5.5 percent per year. This growth is due primarily to innovation rather than improvements in efficiency. Of the nineteen LECs in the sample, eleven were operating efficiently throughout the entire 1988–1999 period. Of the remaining eight, four showed a slight improvement in efficiency while the efficiency of four declined. In the aggregate, however, there was virtually no change in efficiency. Finally, a comparison is made between two methods of estimating the change in productivity. The conventional growth accounting approach yields a lower estimate of the rate of change in productivity than the Malmquist index approach yield. The difference between these estimates is interpreted as the lower bound of the bias associated with the conventional growth accounting approach to measuring the growth in productivity.