FTC Staff Comment Before the Postal Rate Commission In the Matter of Express Mail Rulemaking

CDMMISSION 	AUTHORIZEI
BEFORE THE
UNITED STATES OF AMERICA POSTAL RATE COMMISSION
WASHINGTON, D.C. 20268-001
Express Mail Rulemaking, 1988 	Docket No. RM88-2
BRIEF, IN THE FORM OF COMMENTS, OF
THE STAFF OF THE BUREAU Of ECONOMICS OF THE
FEDERAL TRADE COMMISSIONl
(submitted October 14, 1988)
I. 	INTRODUCTION
The staff of the Bureau of Economics of the Federal Trade Commission
respectfully submits these comments to the Postal Rate Commission (PRC) in
the 	matter 	of 	the 	Express 	Mail 	Rulemaking, 	Docket 	No. 	RM88-2. 	Under
procedures 	proposed 	by 	the 	United 	States 	Postal 	Service 	(USPS) 	in 	this
rulemaking,2 Express Mail rate changes would be reviewed 	more rapidly by
the PRC, and Express Mail rates could be set as low as "attributable costs,"
in 	response 	to 	rates 	set 	by 	one or 	more 	competitors. 3 	The 	USPS 	believes
1 These 	comments 	represent 	the 	views of 	the 	staff of 	the 	Bureau of
Economics of the Federal Trade Commission. 	They are not 	necessarily the
views of the Commission or any individual Commissioner. 	Questions about
these 	comments 	may 	be 	addressed 	to 	John 	C. 	Hilke, 	Federal 	Trade
Commission, Bureau of Economics, 6th Street and Pennsylvania Avenue, N.W.,
Washington, D.C. 20580, telephone: (202) 326-3483.
2 The new set of rules "would feature automatic 	intervention of, and
service on, interested parties, and issue limitation. 	Hearings would be held
only if required to resolve a genuine issue of material 	fact, and 	would 	be
expedited as much as possible, consistent with due process. 	The 	rules also
provide for expedited issuance of a recommended decision." 	"Petition of the
United States Postal Service for a Rulemaking to Establish a New Procedure
for Adjusting Rates for Express Mail Service between Omnibus Rate Cases,"
filed April 29, 1988, pp. 8-9.
3 Conceptually, 	the 	attributable 	costs 	of 	a 	particular 	class 	of 	mail
service 	include 	all 	costs 	that 	occur 	solely 	because 	that 	class 	of 	service 	is
offered. 	See Opinion 	and 	Recommended 	Decision 	of 	the 	United 	States of

that 	it 	is 	not 	an effective competitor 	in 	expedited 	mail 	service 	because 	it
currently cannot match competitors' prices in a timely manner.
The PRC has invited views through a notice published in the Federal
Register" and has established a schedule for receiving comments 5 concerning
the appropriateness of accelerated 	rate review and the optimal form of any
such review.
Our analysis leads us to favor granting accelerated review of proposed
Express Mail rate changes as an inteQral part of reducing rate regulation for
America 	Postal 	Rate 	Commission 	(Docket 	No. 	R87-1), 	Vol. 	I., 	Washington,
D.C.: PRC, 	1988, pp. 96-107. 	The 	requirement that 	rates at 	least 	be set 	to
cover 	attributable 	costs 	for 	each 	class 	of 	mail 	is 	contained 	in 	Section
3622(b)(3) of the 1970 postal reforms. 	It requires "that each class of mail or
type of mail service bear the direct and indirect postal costs attributable to
that class or 	type plus 	that portion of all other costs of the Postal Service
reasonably assignable to such class or type [.]"
Under the USPS's proposal, the maximum rates for Express Mail would
continue to be the rates set through the most recent omnibus rate hearings,
held in 	1987. 	Petition of the USPS to the PRC (Docket No. RM88-2), p. 9.
The rationale for setting maximum rates for Express Mail, despite the large
number of private competitors, is that some individual consumers may have
limited 	alternatives 	to 	Express 	Mail 	and 	therefore 	the 	USPS 	may 	have
market power with respect to these consumers. 	Because the network of post
offices accepting express mail is more extensive than the network of offices
of 	private 	firms 	(approximately 	26,000 	out 	of 	29,000 	post 	offices 	accept
Express 	Mail), 	consumers' 	transportation 	costs 	to 	reach 	an 	Express 	Mail
office 	are 	often 	less 	than 	costs 	to 	reach 	offices 	of 	competing 	firms.
Consequently, if Express Mail prices rose significantly, some consumers might
not 	be able to economically 	turn 	to other suppliers and 	might have 	to 	pay
the higher price or forego the service entirely. 	Opinion and Recommended
Decision 	of the 	United 	States of 	America 	Postal 	Rate Commission 	(Docket
No. R87-1), Vol. I., Washington, D.C.: PRC, 1988, p. 755.
• Federal Register 53:122 (June 24, 1988), p. 23,776.
5 Presiding Officer's Ruling Esfi5TiShing Proceaur':iI-Schedule~Appendix
A (RM88-2/l), dated July II, 1988.
2

both private and public suppliers of expedited mail service. 6 	Currently, both
the USPS and private firms in the expedited mail industry are restricted by
rate 	regulations. 	Rates 	for 	Express 	Mail 	are 	established 	after 	extensive
review by the PRe and approval by the USPS's Board of Governors. 	Express
Mail rates cannot be revised to respond to changes in competitors' prices or
to 	changes 	in 	costs 	without 	what 	it 	regards 	as 	lengthy 	and 	extensive
hearings. 	Minimum 	rates 	for 	private 	firms 	are 	set 	by 	postal 	service
regulations governing exemptions to the private express statutes. 7
Both economic theory and experience indicate that competitive markets
provide the best economic performance. 	Competition provides incentives to
improve economic performance, that is, to minimize costs, to improve quality,
and 	to 	innovate 	with 	new 	goods 	and 	services 	and 	with 	new 	ways 	of
producing goods and services. 8 	Consumers benefit from lower prices, better
quality, and a wider variety of services. 	We concur with the USPS and the
PRC 	that 	effective 	competition 	can 	provide 	these 	same 	benefits 	in 	the
expedited 	mail service industry.9 	Price regulations that are 	unnecessary 	to
6 These 	comments 	apply 	strictly 	to 	Express 	Mail 	and 	do 	not
necessarily 	apply 	to 	the 	more 	general 	question 	of 	rate 	flexibility 	in 	other
classes 	of 	mail service, where 	private firms 	compete 	with 	the 	USPS, or 	to
questions concerning rate regulation of the USPS in general.
7 The 	exemptions 	are 	contained 	in 	39 	CF.R. 	320.6. 	The 	private
express 	statutes 	are 	contained 	in 	18 	U.S.C, 	sections 	1693-1699. 	They
impose criminal sanctions on private firms that offer letter mail service.
8 This is 	the 	fundamental 	economic rationale 	for 	markets. 	See F. M.
Scherer, 	Industrial 	Market 	Structure 	and 	Economic 	Performance, 	:nd
edition, Chicago: Rand McNally, 1980.
9 See the testimony of the US·pS-'-s-economic-experrin--this-tulcmakirig;----- -. - 	--
Dr. Alfred E. Kahn, p. 27. 	Also, see Opinion and Recommended Decision of
the 	United 	States of 	America 	Postal 	Rate 	Commission 	(Docket 	No. 	R87-1),
Vol. 1., Washington, D.C: PRC, 1988, pp. 96-125.
3

maintain competition or to correct market failures have generally been found
to 	reduce 	competition 	and 	consumer 	welfare. 	Conversely, 	removing 	such
regulations 	generally 	increases 	competition 	and 	improves 	economic
performance. IO 	Consequently, we concur with 	the USPS 	that reducing rate
regulation can increase competition and 	benefit consumers in the expedited
mail industry.l1
To spur competition and increase efficiency, we believe that the USPS's
proposals should be expanded by the PRC to reduce rate regulation of both
Express 	Mail 	and 	private 	delivery 	firms. 	In 	particular, 	if 	the 	PRC 	can
obtain 	assurances 	that 	the 	USPS 	will 	revise 	its 	regulations 	to 	reduce 	the
minimum rates that private firms can charge for expedited mail service, we
believe 	that 	the 	PRC 	could 	safely 	grant 	a "zone of discretion" 	in 	pricing
Express 	Mail, 	rather 	than 	just 	an 	accelerated 	review 	process. 	The 	upper
limit 	of 	the 	zone 	would 	be 	determined 	through 	the 	omnibus 	rate 	hearing
process; 	the 	lower 	limit 	would 	be 	attributable 	costs, 	including 	the
adjustments we propose to account for 	tax exemptions and subsidies. 	Price
changes within this zone could be made without further review. 	Reductions
in 	rate 	regulation 	for 	both 	government and 	private firms 	in 	this 	industry
would, we believe, provide a fair 	market test for 	Express Mail and benefit
consumers by enhancing the effectiveness of competition.
10 	P. Joskow and N. Rose, "The Effects of Economic Regulation," MIT
Department of Economics Working Paper No. 447, April 1987.
11 "Petition 	of 	the 	United 	States -P"ostar SerVJceTOr~a"-R\ifemakrn-g"-to-"--- 	-
Establish 	a 	New 	Procedure 	for 	Adjusting 	Rates 	for 	Express 	Mail 	Service
between Omnibus Rate Cases," filed April 29, 1988, pp. 4-8.
4

A fair market test can occur only if firms are able to compete without
any disadvantages unrelated to the quality and price of services offered in
the 	market. 12 	Without 	a 	fair 	market 	test, 	Express 	Mail 	could 	develop
excessive costs 	that 	waste 	scarce 	resources 	because 	its 	tax 	exemptions 	and
government 	subsidies 	could 	insulate 	it 	from 	competition 	and 	allow
unnecessary costs 	to arise. 	Express 	Mail 	might also fail 	to supply services
with the combinations of price and quality that consumers prefer because its
unrelated advantages would diminish the urgency of adopting these types of
innovations. 	Innovations of competitors would 	have to be extraordinary to
overcome 	Express 	Mail's 	unrelated 	advantages. 	All 	of 	these 	effects 	would
harm consumers and waste resources.
Following 	a 	brief 	statement 	of 	the 	expertise 	of 	the 	FTC's 	staff 	in
postal matters, we discuss, in turn: 	I) the rationale for granting accelerated
rate 	review 	for 	Express 	Mail, 	2) 	the 	potential 	inefficiency 	and
anticompetitive effects of regulatory relief in pricing Express Mail without
providing similar relief for 	private firms, 3) a 	necessary adjustment in the
calculation of attributable cost, if attributable cost is to be used as a price
floor 	for 	Express 	Mail 	rates, 	and 	4) 	a 	"zone 	of 	discretion" 	alternative 	to
accelerated 	rate 	review 	that 	could 	provide 	additional 	cost 	savings 	and
benefits for consumers.
_.- - 	--_._--
12 The USPS is disadvantaged by regulatory rate inflexibility. 	Private
firms are disadvantaged by minimum rate restrictions and subsidies received
by the USPS.
5

II. 	FEDERAL TRADE COMMISSION STAFF EXPERTISE
The FTC is an independent regulatory agency responsible for fostering
competition and safeguarding the interests of consumers.J3 	The staff of the
FTC, upon request by federal, state, and local government bodies, regularly
analyzes regulatory and legislative proposals to identify provisions that may
aIter 	competition 	or 	production 	costs, 	or 	cause 	other 	changes 	in 	costs 	or
benefits to consumers.
The 	FTC 	staff 	has 	commented 	on 	several 	previous 	issues 	before 	the
PRC, including: 1) use of a single set of rate hearings to establish a series
of rate changes;I" 2) elaboration of competition issues inherent in proposed
electronic 	computer 	originated 	mail 	(E-COM) 	rate 	and 	classification
changes;15 3) drawbacks to proposed modification of the test period for cost
recovery 	in 	E-COM;16 4) 	advantages 	of setting 	E-COM 	rates 	to 	cover 	full
costs;17 and 5) costs and benefits of current preferred mail rates. 18
13 15 U.S.c. Section 41 tl~.
H 	PRC Docket No. MR82-3, filed November 4, 1982.
15 PRC Docket No. R83-1, filed June 1, 1983.
16 PRC Docket No. R83-1, filed June 16, 1983.
17 PRC Docket No. R84-1, filed December 23, 1983.
18 PRC 	Docket 	No. 	SS86-1, 	filed 	April 	20, 	1986. 	Preferred 	mail 	is
mail 	that 	is 	granted 	a 	rate 	discount 	because 	it 	is 	viewed 	as 	meritorious.
Other types of postal discounts are cost justified. 	Preferred mail discounts
are 	granted, 	for 	example, 	for 	educational 	materials 	and 	for 	mailings 	of
nonprofit 	organizations. 	Congress 	pays 	the 	USPS 	to 	make 	these 	discounts
for preferred mail a vaila ble.
6

III. 	THE BENEFITS OF GRANTING ACCELERATED REVIEW
OF RATF CHANGES FOR EXPRESS MAIL
Freedom to adjust rates quickly and easily is often an essential element
in a competitive market. 	We believe that this is likely to be the case in the
expedited 	mail 	industry 	and 	we 	are, 	therefore, 	in full 	agreement 	with 	the
stated intent of the USPS's proposal, to increase competition in the industry
by increasing rate f1exibility.19 	To dcny this flexibility in an industry may
raise operating costs, increase risk, make strategic planning of new facilities,
inventory, and staffing requirements more difficult, and encourage predatory
conduct. 	All 	of 	these 	types 	of 	efficiency 	losses 	occurred 	in 	the 	railroad
industry, 	for 	example, 	under 	cumbersome 	Interstate 	Commerce 	Commission
price regulations. 2o 	When only selected participants in a 	market are bound
by price regulations, they are likely to be unable to compete effectively with
their rivals, thereby reducing competition in the market generally.
The USPS's proposals should increase 	rate flexibility 	and 	reduce costs
for 	Express Mail 	by reducing the time and effort 	required 	to revise 	rates,
but the proposed procedures would continue to impose significant lags (that
may 	impair 	the 	USPS's 	ability 	to 	quickly 	respond 	to 	changing 	market
conditions) and administrative costs.
19 Testimony of Dr. Alfred E. Kahn, pp. 11-14.
20 See, 	e.g., 	Improving 	Railroad 	Productivity, 	Washington, 	D.C.: 	The
National Commission on Productivity and the Council of Economic Advisors,
1973.
7

IV. 	POTENTIAL COSTS: INEFFICIENCY AND ANTI COMPETITIVE
EFFECTS OF THE USPS'S PROPOSAL
A. 	Overview
The 	USPS's 	proposal, 	in 	our 	view, 	poses 	two 	significant 	threats 	to
economic 	efficiency 	and 	competition. 21 	First, 	while 	the 	USPS's 	propos:lIs
would reduce price regulation of Express Mail, they would leave regulatory
rate 	restrictions 	on 	private 	firms 	unchanged. 	If 	competitors 	were 	not
allowed 	to 	match 	the 	Postal 	Service's 	prices 	for 	Express 	Mail, 	the 	USPS's
21 We do not claim 	that the two problems we have 	identified are the
only ones 	that 	exist. 	The 	PRC 	may discover 	other 	potentially 	inefficient
aspects of the proposed procedures.
We 	agree 	with 	the 	testimony 	(page 	6) 	of 	the 	USPS's 	expert 	witness,
Dr. 	Alfred 	Kahn, 	that 	the 	appropriateness 	of 	granting 	increased 	rate
flexibility 	in 	Express Mail 	depends 	initially 	upon 	whether 	the 	government
should 	be 	providing 	Express 	Mail 	service 	at 	all. 	Economic 	efficiency
requires 	that 	government 	produce 	or 	provide 	services 	only 	when 	there 	is
reason 	to 	believe that private 	markets will 	fail 	to do so adequately. 	This
principle 	is 	embodied 	in 	government 	policies 	that 	have 	been 	in 	operation
since 1955 (Office of Management and Budget Circular A-76 (Revised) August
4, 	1983). 	The 	presence 	of 	vigorous 	competition 	from 	several 	private 	for-
profit firms is strong evidence that such market failure, if any, 	is limited.
Indeed, the USPS petition in this rulemaking is premised on the assumption
that private firms provide vigorous competition. 	Petition of the USPS to the
PRC (Docket RM88-2), p. 5.
One rationale 	for 	the USPS's 	involvement 	in expedited 	mail 	could 	be
economies 	of 	scope 	between 	Express 	Mail 	and 	statutorily 	protected 	(from
competition) classes of mail services, particularly first class mail. 	Dr. Kahn
assumes 	in 	his 	written 	testimony 	(p. 	7) 	that 	there 	are 	economically
compelling 	economies 	of 	scope. 	Empirical 	support 	for 	this 	proposition,
however, 	is 	not definitive, to the 	best of our 	knowledge. 	The 	Department
of 	Justice 	is 	investigating 	this 	question. 	We 	note 	that 	the 	compelling
economies 	of 	scope 	hypothesis 	is 	at 	least 	partially 	inconsistent 	with 	the
fact 	that 	the 	leading 	expedited 	delivery 	firm, 	Federal 	Express, 	has 	not
participated appreciably in other types of delivery services, while some of its
less successful 	rivals have. 	Competitors and Competition of the 	U.S. Postal
Service 19 (1987), Section II.
8

proposal could result 	in a waste of scarce resources, by 	both the USPS and
by 	private 	firms, 	and 	result 	in 	higher 	prices 	and 	reduced 	options 	for
consumers. 	Therefore, we favor allowing private firms to match the USPS's
price/quality 	offerings 	for 	expedited 	mail 	service 	as 	a 	prerequisite 	to
providing 	the 	USPS 	with 	greater rate 	flexibility. 	Second, 	the 	attributable
cost 	rate 	floor 	for 	Express 	Mail, as currently defined, 	is 	likely 	to 	be 	less
than 	its 	real 	attributable 	costs. 22 	The 	current attr·ibutable-cost 	calculation
for 	Express 	Mail 	does 	not 	include 	an 	adjustment 	for 	the 	value 	of 	postal
subsidies. 	These 	subsidies 	consist 	of 	items 	such 	as 	tax 	exemptions 	and
employee retirement and medical benefit paid by the U.S. government rather
than 	postal 	patrons. 	We believe 	that attributable cost should 	be calculated
differently in order to establish the minimum rates for Express Mai1. 23
B. 	Interaction between Attributable Cost Pricing and Restrictions on Private
Competitors' 	Pricing 	if 	Express 	Mail 	Is 	Priced 	Close 	to 	the "Urgent" 	Mail
Rate Exemption
Private 	firms 	are 	generally 	forbidden 	to 	offer 	mail 	service 	in
competition with the USPS, but an exemption is provided for "urgent" mail. 24
22 We 	assume 	here 	that 	properly 	measured 	attributable 	costs 	are 	a
reasonable substitute for long-run marginal cost.
23 This would not require any changes in the subsidies received by the
USPS or in its tax status~ 	We suggest only that the PRC require the USPS
to set the minimum rates for 	Express Mail as if it did 	not enjoy these tax
exemptions and other subsidies. 	Reducing the Deficit: Spending and Revenue
Options, Washington, D.C.: Congressional Budget Office, 1988, pp. 270-27 J.
----- _.. _---
24 39 	CFR 	320.6(b) 	and 	(c)(1987)-:- 	Til 	fact,-t~' USPS'g- re-g-ufations
have 	established 	two 	criteria 	for 	obtaining 	an 	urgent 	letter 	exemption: 	a
rate 	exemption, 	and 	a 	"loss 	of 	value" 	exemption. 	However, 	petitioners 	in
the 	most 	recent 	omnibus 	rate 	hearings 	maintained 	that 	only 	the 	rate
9

The 	USPS's 	rate 	criterion 	for 	the 	urgent 	mail 	exemption 	requires 	that
private firms charge at least $3 per item, or twice the first class mail rate,
whichever is higher. 25 	The USPS established this set of minimum prices in
the apparent belief that private mail services offered at prices higher than
these do not threaten demand for statutorily protected classes of mail (e.g.,
first 	class 	mail). 	Arguably, 	however, 	these 	minimum 	prices 	are 	set
unnecessarily 	high. 26 	We 	believe 	that 	experience 	in 	Great 	Britain 	with 	a
much 	lower 	exemption 	rate 	may 	be 	instructive. 	In 	Great 	Britain, 	the
minimum price of one pound (approximately $1.50) applies to all 	letters of
criterion provides a practical, clear-cut, and easily demonstrated standard for
Obtaining 	an 	exemption. 	"Statement 	of 	the 	Air 	Courier 	Conference 	of
America to the President's Commission on Privatization," January 28, 1988, p.
4. 	The 	loss 	of 	value 	exemption 	requires 	that shippers 	prove 	to 	the USPS
that 	the 	value 	or 	usefulness 	of 	a 	shipment 	will 	be 	"lost 	or 	greatly
diminished" if the shipment is not delivered within certain time limits.
25 	39 	CFR 	320.6 	(c) 	(1987). 	This 	price 	test 	was 	reportedly 	the
subject 	of 	considerable 	controversy 	when 	it 	was 	adopted. 	Several
government and private commenters, including the Council on Wage and Price
Stability, advocated much lower rates for the exemption during the hearings
in 	1979. 	"Initial 	Brief 	of 	the 	Air 	Courier 	Conference of 	America," 	PRC
Docket No. R87-1 (1987), p. 9.
26 For 	a 	background 	discussion, 	see 	Privatization: 	Toward 	More
Effective 	Government, 	Report 	of 	the 	President's 	Commission 	on
Privatization, 	1988, 	pp. 	120-121, 	and 	"Initial 	Brief 	of 	the 	Air 	Courier
Conference of America," PRC Docket No. R87-1 (1987), pp. 4-7.
The 	PRC does not directly 	review 	the USPS's criteria 	for 	exemptions
to 	the 	private 	express 	statutes, 	but 	the 	PRC 	has 	recognized 	the 	potential
impact 	of 	these 	regulations 	on 	competition 	in 	the 	expedited 	mail 	industry
has amended Express Mail rates proposed by the USPS to accommodate this
concern. 	Further, 	the 	PRC 	has 	urged 	the 	USPS 	"to 	re-visit 	its 	decision
concerning the test for extremely urgent letters in its regulations in light of
the 	changes 	in 	the 	market." 	Opinion 	and 	Recommended 	Decision 	of 	the
United 	States of 	America 	Postal 	Rate Commission (Docket 	No. 	R87-1), 	Vol.
1., Washington, D.C.: PRC, 1988, pp. 749-751.
Proposals 	before 	the 	President's 	Commission 	on 	Privatization
recommended establishing the exemption rate at $1.
10

any weight. 27 	There has been no detectable adverse effect on demand 	for
first class mail service resulting from allowing a lower exemption rate. 28
The $3 minimum rate may cause a number of economic inefficiencies.
Of 	direct 	relevance 	here 	IS 	the 	potential 	anticompetitive 	effcct. 29
Essentially, the USPS regulates competitors' minimum rates, yet Express Mail
could 	effectively 	be 	priced 	below 	the 	rates 	that 	at 	-least 	some 	equally
efficient competitors could 	legally charge. 	By 	focusing only on 	price, 	the
"meeting-competition" provision in the USPS's proposal ignores the effect of
27 The 	Postal 	Privilege 	(Suspension) 	Order 	1981, 	1981 	No. 	1483,
Minister 	of 	State, 	Department 	of 	Industry, 	coming 	into 	operation 	on
November 7, 	1981. 	The first class letter rate 	in Great Britain 	is 	18 pence
(approximately $.27).
Canada 	has 	also 	established 	a 	considerably 	lower 	exemption 	rate 	at
three 	times 	the 	first 	class 	postage 	on 	a 	50 	gram 	letter 	of 	$.37 	Canadian
(approximately $.30). 	As in Great Britain, no higher minimum rate applies to
heavier 	items. 	Canada 	Post 	Corporation 	Act, 	assented 	April 	23,1981,
sections 14 and 15.
28 Report 	and 	Accounts 	1987-1988, 	Postal 	Service 	of 	the 	United
Kingdom, 1988, p. 10.
29 Some private firms, 	particularly entrepreneurs operating small 	local
courier 	services, 	believe 	that 	they 	could 	profitably 	provide 	expedited 	mail
service at rates below the rates that they are permitted to charge under the
USPS's exemption 	regulations. 	On 	heavier items, many 	private competitors
believe that they can profitably price below the allowed rates. 	Opinion and
Recommended 	Decision 	of 	the 	United 	States 	of 	America 	Postal 	Rate
Commission (Docket No. R87-1), Vol. I., Washington, D.C.: PRC, 1988, p. 749,
"Statement 	of 	the 	Air 	Courier 	Conference 	of 	America 	to 	the 	President's
Commission on Privatization," January 28, 1988, pp. 4-5.
If the price floor for 	private competitors exceeds the costs of private
firms, 	it 	may 	create 	excessive 	quality-based 	competition 	between 	private
competitors. 	Firms will seek to increase demand for their services by adding
amenities 	until 	costs 	approach 	the 	level 	of 	the 	price 	floor. 	This 	harms
consumers 	by 	eliminating 	services 	that 	combine 	lower 	prices 	and 	fewer
amenities, 	a 	combination 	that 	many 	consumers 	may 	prefer 	to 	other
alternatives. 	Costs 	became 	inflatedi!!.-t.he 	ait:.line 	industry, 	for 	example,
when regulated air fares exceeded minimum costs. 	-----".-------.._- -----------.----~_. ----- ~ -
A higher than necessary 	rate price floor 	for 	private firms 	would also
prevent a fair market test of the USPS's Express Mail service.
II

substitution between price and Quality aspects of a service. so 	For example,
consider an equally efficient private supplier offering a service with fewer
features 	than 	Express Mail and 	consequently needing 	to charge at least $1
less than 	Express Mail 	to attract customers. 	Assume 	that the 	private firm
initially 	charges 	the 	legal 	minimum 	of $3 	for 	a 	one ounce 	letter and 	the
Express Mail rate is $4 ($3 of which is attributable costs). 	If Express Mail
reduces 	its 	price 	to 	$3, 	to 	"meet" 	competition, 	the .private 	firm 	would 	be
unable to compete, because the USPS's urgent letter rate exemption sets the
minimum 	price 	for 	private 	firms 	at 	$3. 	Even 	if 	the 	private 	firm 	could
otherwise 	reduce 	its costs and 	price at $2, it could 	not 	legally do 	so .. In
this scenario, consumers would be denied the combination of low prices and
minimal service from the private firm that they might have patronized, had
the regulated $3 minimum price been lower. 31
If even one local competitor was able to Qualify for the loss of value
exemption,32 it 	would 	become exempt from 	the $3 	price floor 	facing 	other
private 	competitors 	and 	could 	price 	below 	$3. 	Because 	of 	prohibitions
against the USPS charging different prices for the same service to different
30 The next section describes 	how 	government subsidies 	may similarly
distort the effects of Express Mail prices.
31 Similarly, 	entrants 	without 	established 	reputations 	for 	performance
Quality 	may 	have 	to 	charge 	less, 	at 	least 	initially, 	in 	order 	to 	induce
consumers 	to 	try 	their 	service. 	Pricing 	by 	the 	USPS 	close 	to 	attributable
cost, 	while 	maintaining 	a 	high 	price 	floor 	for 	private 	competitors, 	could
effectively 	preclude 	new 	entry 	by 	firms 	that 	would 	eventually 	be 	equally
efficient competitors.
32 See footnote 24 supra.
12

customers,SS 	the 	USPS 	might 	be 	permitted, 	under 	the 	USPS's 	proposal, 	to
price 	below $3, 	nation-wide, 	in 	response 	to 	pricing 	below $3 	by 	a 	private
firm in one area. 	Meanwhile, other private firms in that local area and in
other areas would continue to be constrained by the $3 rule. 	If this series
of events took place, the USPS might be able to monopolize the industry in
some areas because of the $3 rule. 34 	Of course, the loss of value exemption
may 	have 	this anticompetitive effect 	with any 	price floor. 	To the extent,
however, that the price floor can be lowered without eroding the demand for
protected 	classes of 	mail, 	the opportunity 	for 	the 	loss of 	value exemption
and the price floor to interact in this anticompetitive manner is reduced.
Lack 	of 	effective 	competition 	for 	Express 	Mail 	under 	either 	of 	the
conditions above may erode the USPS's incentives to minimize costs, improve
quality, and innovate. 	For example, assume that competitors are required to
price above $3, and that attributable costs for Express Mail are $2.50, when
Express 	Mail 	is 	operated 	with 	minimum 	costs. 	Under 	these 	conditions,
excessive 	attributable 	costs 	for 	Express 	Mail 	could 	rise 	by 	$.50 	before
competition 	from 	other suppliers could 	halt the build-up of excessive costs
for Express Mail.
SS Section 403(c) of the postal 	reorganization 	statute forbids 	undue or
unreasonable 	discrimination 	among 	mailers 	and 	undue 	or 	unreasonable
preference to a 	mailer. 	Opinion and 	Recommended 	Decision of the United
States 	of 	America 	Postal 	Rate 	Commission 	(Docket 	No. 	R87-1), 	Vol. 	1.,
Washington, D.C.: PRC, 1988, p. 747.
34 In 	the 	area 	where 	the 	private 	firm 	obtained 	the 	loss 	of 	value
exemption, 	the 	USPS 	would 	share 	the -mnket 	with 	thisone"c6mpetifortr--
they both priced below $3. 	In other areas, the USPS might be able to price
below $3 without facing any competitors allowed to price below $3. 	In these
areas, the USPS might be able to monopolize expedited mail service.
13

In summary, the interaction between the regulated price floor governing
private firms and the attributable cost price floor applicable to Express Mail
creates a potential source of inefficient and anticompetitive pricing that can
best 	be 	eliminated 	by 	allowing 	competitors 	to 	match 	or 	beat 	any
price/quality 	offerings 	for 	Express 	Mail. 35 	Without 	this 	concurrent
relaxation of rate regulations on private firms, these firms might not be able
to provide a fair 	market test for 	Express Mail over .a range of prices near
the "urgent mail" exemption rate. 36 	In this range of rates, the "urgent mail"
rate exemption regulations could 	prevent private firms from even matching
Express Mail's price/quality offerings. 	We suggest that the PRC assure that
private firms are allowed at least to match price/quality offerings by Express
Mail 	at 	the 	same 	time 	that 	the 	USPS 	is 	granted 	additional 	flexibility 	in
pricing 	Express Mail. 37 	We 	wish 	to emphasize 	that we 	have 	not analyzed
the 	question 	of 	specific 	minimum 	rates 	necessary 	to 	protect 	statutorily
monopolized classes of mail, nor have we addressed the general question of
the regulatory necessity of maintaining a minimum rate for private expedited
mail 	services. 	We 	suggest 	only 	that 	detailed 	study 	of 	the 	British 	and
Canadian exemptions, discu~sed above, could provide useful guidance.
35 This 	effect 	will 	occur 	even 	if 	attributable 	costs 	are 	adjusted 	as
suggested 	in 	the 	next 	section of 	these 	comments, 	but 	the 	effect 	would 	be
worse without the adjustment in attributable costs.
36 The anticompetitive effect could take place over a range of Express
Mail rates above $3 if Express Mail included many service extras that would
force 	private 	firms, 	with 	fewer 	extra 	services, 	to 	cease 	offering 	such 	"no
frills" service unless they were allowed to price below $3.
37 An 	alternative 	to 	lowering-the- price' f106r---orthe' urgent-letter
exemption 	might 	be 	to 	increase the certainty of qualifying 	for 	the 	loss 	in
value exemption.
14

C. 	Necessary Ad justments in the Attributable Cost Calculations for Express
Under 	existing 	procedures, 	the 	prices 	for 	Express 	Mail 	service 	are
determined during the omnibus postal rate hearing process. 	Prices are set to
recover 	USPS's 	calculations 	of 	attributable 	costs, 	plus a 	mark-up.38 	From
an 	economic 	perspective, 	the 	attributable 	cost 	calculated 	to 	establish 	the
minimum rates for Express Mail ideally should include all appropriate costs.
The 	USPS's 	current 	calculation 	of 	attributable 	cost 	excludes 	some
significant costs that should be included. 	The USPS has several major cost
advantages that originate not from its own efficiency, but from its status as
a 	government-owned enterprise. 	These cost advantages do 	not 	involve real
resource savings for society, and the minimum price floor for 	Express Mail
service 	should 	account 	for 	these 	cost 	advantages. 39 	The 	major 	cost
advantages 	of 	this type accorded 	to the 	USPS consist of the 	following: 	I)
exemption 	from 	state 	and 	local 	sales, 	property, 	and 	income 	taxes; 	2)
exemption 	from 	federal 	income 	taxes; 	3) 	access 	to 	below-market 	rates 	of
38 Previous 	rate 	hearings 	have 	raised 	significant 	questions 	about 	the
reliability 	of 	the 	allocations. 	Most 	criticisms 	have 	suggested 	that 	the
allocations 	understate 	costs 	attributable 	to 	Express 	Mail. 	Opinion 	and
Recommended 	Decision 	of 	the 	United 	States 	of 	America 	Postal 	Rate
Commission (Docket No. R87-1), Vol. 1., Washington, D.C.: PRC, 1988, p. 736.
39 False 	cost 	disadvantages 	of 	the 	Express 	Mail 	would 	have 	the
opposite 	effect, 	although 	none 	have 	been 	identified, 	to 	our 	knowledge.
Express 	Mail 	may 	have 	some 	cost 	disadvantages 	that 	are 	real. 	Real 	cost
disadvantages 	are 	equivalent 	to 	e-ice-sslve -c·osts -(discussecCTn -ih-e- previous
section of 	these 	comments) 	in 	their effect 	on 	resource 	waste 	and 	harm 	to
consumers.
15

financing, attributable to the Federal government's guarantee to repay loans
made to the USPS; and 4) subsidization of unfunded liability for medical and
retirement benefits to be paid to workers after retirement.4o
To 	avoid 	treating 	the 	USPS's 	government-based 	cost 	savings 	as 	real
cost savings, we suggest that the calculation of attributable costs of Express
Mail service, at least for 	use in setting minimum rates, be adjusted upward
to 	reflect 	the value of 	these advantages of 	government status. 	Only 	after
adjustment 	for 	these government 	benefits could attributable costs constitute
an economically appropriate guide in setting the rate floor for Express Mail
rates. 41
If Express Mail were offered at the unadjusted attributable cost level,
an equally efficient private firm would not be able to compete with Express
Mail -- the firm could price as low as attributable cost, but the USPS could
still undercut this price because of the subsidies and tax exemptions that the
USPS 	receives. 	In 	fact, 	competitors 	would 	be 	limited 	in 	their 	ability 	to
prevent the costs of Express Mail service from rising unnecessarily, because
the 	subsidies 	and 	tax 	exemptions 	would 	insulate 	Express 	Mail 	from
competition. 42 	Taxpayers would pay higher than necessary taxes to finance
40 Reducing 	the 	Deficit: 	Spending 	and 	Revenue 	Options, 	Washington,
D.C.: Congressional Budget Office, 1988, pp. 270-271.
41 A 	similar 	concern 	about 	the 	proper 	treatment 	of 	government
subsidies to the USPS in competitive rate-making has been expressed by the
Congressional Budget Office. 	Reducing the 	Deficit: Spending and 	Revenue
Ootions, Washington, D.C.: Congressional Budget Office, 1988, pp. 270-271.
,(2 At 	the extreme, excess costs of 	Express Mail 	would 	have 	to exceed
the 	level 	of 	the 	government-based 	cost 	advantages 	before equally 	efficient
competitors could beat Express t\13il prices.
16

government-based 	cost 	advantages, 	and 	consumers 	would 	pay 	higher 	than
necessary prices for expedited mail as a result.
We 	suggest 	that 	Express 	Mail's 	attributable 	costs, 	for 	the 	purpose 	of
establishing 	minimum 	rates 	for 	Express 	Mail, 	be 	increased 	to 	reflect 	the
subsidies 	received 	from 	the 	government. 	This 	would 	alleviate 	part 	of 	the
anticompetitive potential of allowing the USPS to lower its rates for Express
Mail to those charged by its rivals.
V. 	AN ALTERNATIVE TO ACCELERATED RATE REVIEW:
ESTABLISHING A "ZONE QF DISCRETION" IN PRICING EXPRESS MAIL
Apart from the potential costs of increasing rate flexibility for Express
Mail 	identified 	above, 	there appears to 	be 	little economic 	justification 	for
imposing 	additional 	delays 	or 	administrative 	costs 	on 	the 	USPS's 	pricing
decisions 	for 	Express 	Mail. 	Consequently, 	we 	suggest 	consideration 	of 	a
"zone 	of 	discretion" 	in 	pricing 	Express 	Mail 	if 	the 	potential 	costs 	can 	be
eliminated 	or 	substantially 	reduced. 43 	Unlike 	the 	USPS's 	proposal, 	which
continues 	to 	require 	hearings 	and 	delays 	for 	each 	rate 	change, 	a 	zone 	of
43 Implementation of a 	zone 	of discretion 	in 	the 	rate 	making 	process
may 	require 	the 	PRC 	to 	seek 	additional 	legislative 	authority. 	We 	note,
however, 	that 	both 	the 	USPS 	and 	the 	PRe's 	Office 	of 	the 	Consumer
Advocate have commented on the negative implications for competition and
efficiency 	of 	procedural 	requirements 	that 	hinder 	adopting 	a 	zone 	of
discretion 	approach 	and 	the 	advantages 	of 	taking 	a 	zone 	of 	discretion
approach 	in 	regulating Express Mail 	rates. 	See, "Response to 	Memorandum
of 	the 	United States 	Postal Service, 	Docket 	No. 	RM88-2," 	filed 	August 	IS,
1988, pp. 2 and 3; 	"Testimony of 	A. E. Kahn," p. 27; and "Petition of the
United States Postal Service for a Rulemaking to Establish a New Procedure
for 	Adjusting Rates for 	Express Mail Service between Omnibus Rate Cases,"
filed April 29, 1988, pp. 4-8.
17

discretion 	would entail establishing 	maximum and 	minimum 	rates (possibly
through the normal omnibus rate hearing process) and then permit the USPS
to change Express Mail 	rates within 	the zone of discretion 	without further
regulatory approval. 	This zone would be conceptually similar to the range of
pricing 	granted 	to 	railroads 	by 	the 	amended 	Interstate Commerce 	Act and
the 	Interstate 	Commerce 	Commission." 	The 	upper 	limit, 	in 	this 	instance,
would 	be 	the price established 	through 	the previous omnibus 	rate hearings,
and 	the 	lowcr 	limit 	would 	be 	attributable 	cost, 	adjusted 	for 	the 	subsidies
received by the postal service. 	This approach would leave the USPS free to
charge 	any 	price 	for 	Express 	Mail 	within 	the 	zone 	of 	discretion.(5 	No
further rate review or delay in changing rates would be required.
VI. 	CQNCLUSIQN
Granting the USPS additional flexibility in pricing Express Mail could
provide benefits through greater efficiency. 	Such a change, however, could
also 	harm 	consumers 	if 	regulatory 	advantages 	the 	USPS 	enjoys 	are 	not
simultaneously removed or reduced. 	Without removal or reduction of these
advantages, 	the 	USPS's 	proposal 	might 	pose 	an 	unacceptably 	high 	risk 	of
increased costs from inefficient and anticompetitive pricing. 	Therefore, we
suggest 	that 	the 	USPS 	be 	granted 	additional 	pricing 	flexibility 	after 	two
alterations are 	made to the current 	regulatory system. 	First, 	private firms
should be allowed to lower their rates below the levels now specified in the
H 	See 	L. 	Phillips, 	"The 	Railroad 	Industry: 	The 	Road 	to 	Recovcry,"
Business Economist 21:2 (April 1986), pp. 52-56.
(5 Provided 	that 	the 	rates 	were 	consistent 	with 	other 	laws 	governing
the USPS's pricing activities.
18

.'
urgent mail exemption to match or beat those of Express Mail. 	This would
encourage Express Mail to minimize costs, and would a void excessive quality
competition among private suppliers. 	Second, Express Mail's attributable cost
calculations (at 	least 	for 	purposes of determining 	the minimum 	permissible
rates) should be adjusted upward to reflect the value of subsidies enjoyed by
Express Mail because of its government affiliation. 	This change would insure
that 	the 	USPS's pricing 	better 	reflects the true 	resource costs of providing
Express Mail service.
By making the recommended changes, the potential costs of permitting
greater rate 	flexibility 	for 	Express Mail could 	be eliminated. 	Once this is
accomplished, 	we 	believe 	that 	the 	potential 	benefits 	of 	increased 	rate
flexibility 	could 	best 	be 	realized 	by 	establishing 	a -zone 	of 	discretion 	in
setting 	Express 	Mail 	rates. 	After 	the 	primary 	restrictions 	and 	threats 	to
competition have been removed, the market should be allowed to operate as
freely as possible to benefit consumers.
-----,.- -- ._- ._--- 	-	------_._.- .- _.--
19