Every year since 1995, the Federal Communications Commission (FCC) has released a report on the state of competition in the wireless market. It’s just about to release its fifteenth one. This might not seem like a stop-the-presses moment for everyone in the media, but it’s a big deal for the companies involved—and their customers—because the contents of the report will influence regulatory policy.

Tension hangs in the air in particular this year because of the new ground broken by last year’s 14th Competition Report. That analysis departed from prior years’ reports in three major ways. It expanded its scope to include related markets such as handsets and applications; it failed to find the market “effectively competitive” (the term that characterized the previous years’ conclusions); and it arrived at that new finding thanks to a very different mode of economic inquiry. The first of these differences was applauded, but the second was regarded with skepticism, because the third was frankly indefensible. In shifting its method of analysis, the FCC had opted for making the kind of indirect (and outmoded) economic inferences to which modern economists usually only resort when no direct evidence is available. In fact, direct evidence regarding the state of competition in the wireless ecosystem is easy to obtain and clear in its implications.

The question, therefore, hanging over the 15th Competition Report is whether the Commission will have reacquainted itself with the economic state of the art in its analytical method. Or, if not, what negative effect its dubious conclusions might have on regulatory policy in wireless markets.

All economists recognize that competitive analysis is all about customers; if firms exercise market power, customers suffer through higher prices and foreclosed entry of new competitors. If firms are not exercising market power, competition reigns. Customers get what they demand and regulators can take a blessed vacation from interfering in the market. But traditionally, competitive analysis wasn’t based on the direct observation of what was happening to customers, because economists simply didn’t have the tools to measure that. Regulators learned to rely on indirect measures, such as market share in the relevant markets, the Herfindahl-Hirschman Index, and market definitions.

Then along came the proposed merger of Staples and Office Depot. As the Federal Trade Commission set about determining whether customers would be harmed by that merger, it realized it did not have to make inferences and assumptions. To answer the question of how prices would be affected, it needed only to look at existing markets where one player operated but not the other. When it did that, and found compelling evidence that in markets without the presence of both firms, prices were significantly higher, it denied the merger. That landmark case set a new standard for conducting competitive analysis: since then, the preferred approach has been to assemble direct evidence.

To determine whether firms are exercising monopoly power, it makes sense to look directly at how they are behaving. Remember the old saying “If it walks like a duck and quacks like a duck, then it must be a duck?” Applied here, the relevant inquiry is: Do wireless firms price above competitive levels like monopolists, and exclude new entrants like monopolists? This is the direct approach that is widely embraced by academic economists, and by U.S. federal antitrust agencies. (In 2010, the Horizontal Merger Guidelines were revised to reflect this new thinking in competition analysis.)

Indeed, the oddest thing about last year’s competition report is the fact that the FCC did collect this direct evidence. Its staff did an impressive job of detailing real marketplace developments, for which we commend them. Part IV of the report, titled “Mobile Wireless Services: Provider Conduct,” documents at least eight effective price cuts by wireless carriers in 2009 and 2010. For example, the report notes that (1) AT&T introduced its “A-List” calling feature (which allows unlimited mobile calling to and from any five “VIP” domestic phone numbers) at no additional charge; (2) Sprint introduced unlimited mobile-to-mobile calling at no additional charge; (3) T-Mobile introduced a lower-priced version of its unlimited national voice calling plan, and it reset prices on tiered offerings at significant discounts to its legacy plans; (4) Verizon Wireless reduced the prices of its unlimited voice plans for both individual and shared family offerings, prompting (5) AT&T to do the same; (6) Sprint Nextel reduced the monthly charge on its Boost Unlimited voice and data plan to roughly half the price of the cheapest postpaid version of an unlimited voice and data offering then available; which caused (7) MetroPCS and (8) Leap to enhance their respective unlimited local calling plans by reducing the monthly charges for add-on features.

Meanwhile, according to the Bureau of Labor Statistics, wireless prices decreased by three percent from January 2008 to December 2010, and were roughly 40 percent of the levels experienced in 1997. By comparison, the CPI for all goods and services increased by nearly four percent over the same period.

And yet, the FCC chose to ignore this direct evidence—namely, aggressive pricing behavior, robust entry, and continued long-term downward-trending prices. The report instead elevates inferences of monopoly power based on market shares. For example, in Table 41, the FCC makes much of the combined share of the top two providers, AT&T and Verizon. Ironically, the FCC admits on page 44 that “Shares of subscribers and measures of concentration are not synonymous with market power—the ability to charge prices above the competitive level for a sustained period of time.”

Despite the direct evidence of the lack of pricing power that the staff so ably summarized, the FCC was unwilling to conclude, as it had in the prior six iterations of its competition report to Congress, that the U.S. wireless market was “effectively competitive.”

The FCC staff consists of some of the finest telecommunications economists on the planet, who obviously know that the report’s mode of competitive analysis is woefully behind the current state of the art. So why, we might ask, is the FCC favoring an indirect and outmoded market-share analysis over the impressive direct evidence?

It’s hard to say. But consider that, if the wireless markets are “effectively competitive,” then there is absolutely no reason why the FCC needs regulate them. If they are not “effectively competitive,” this opens the door to FCC intervention into these markets to counter the presumed failure of competition.

A clue that we may be on to something here can be found around page 156 of last year’s report, where the FCC notes that AT&T and Verizon have a competitive advantage due to the location of their spectrum: “For instance, given the superior propagation characteristics of spectrum under 1 GHz, particularly for providing coverage in rural areas and for penetrating buildings, providers whose spectrum assets include a greater amount of spectrum below 1 GHz spectrum may possess certain competitive advantages for providing robust coverage when compared to licensees whose portfolio is exclusively or primarily comprised of higher frequency spectrum.” (A digression: In 2004, at the behest of the public safety community, the FCC pushed Nextel out of its 800 MHz spectrum into the 1.9 GHz, and it made Nextel pay billions for the privilege of giving up spectrum the FCC now says is the “Good Stuff” in exchange for spectrum the FCC now says is the “Bad Stuff.” When did the FCC change its mind?)

We see, then, the FCC both favoring an outmoded market structure analysis, and putting forth an apparently artificial new market definition (i.e., spectrum above 1 GHz vs. below 1 GHz). Again: to what end? Is it possible that the FCC is angling to put a lid on spectrum that AT&T and Verizon can acquire, and therefore to give a leg up to its rivals? If that is the objective, it is certainly not to reverse some price increase. More likely it’s linked to the FCC’s awareness that a finding of “effective competition” would impair its ability to start fiddling with spectrum policy. And how is a firm like AT&T or Verizon supposed to interpret a subtle vow of exclusion from future auctions? Consolidation of existing licensed spectrum becomes the only means to expand capacity for these firms.

As one of us has explained elsewhere, the most important policy issue facing the FCC—and one that should guide its analysis of wireless competition—is the coming spectrum crunch: Cisco recently forecasted wireless data annual growth rates well over 100 percent, principally from the customer demand for television to the handheld. At that rate, carriers will hit their maximum capacity in a few years. By any measure, the industry is approaching a licensed spectrum capacity crisis. Accordingly, policymakers need to get more spectrum into the market and allow licensees the right to buy, sell, trade as they see fit.

As long as this FCC continues to avoid getting major amounts of more, clean spectrum into the marketplace, or strongly hints that future spectrum could be off limits to carriers with specific spectrum portfolios, the agency leaves companies facing capacity shortages in the near term with no solution other than to use the secondary markets. Chairman Genachowski acknowledged in a recent speech that there is a serious spectrum crunch, but he claimed that there is no need for industry consolidation to solve it. He promises action on releasing more spectrum “soon.” Of course, we have heard promises from the FCC about releasing more spectrum “soon” since the National Broadband Plan was issued, and even before that. But apparently soon means a whole lot slower than the exploding wireless market needs.

If regulators are opposed to consolidation as a means of addressing the spectrum crunch, the remedy is not to deny a licensee the right to sell or trade their spectrum as they see fit, but rather to get on the stick and get more spectrum out there faster. As in now.

Gerald R. Faulhaber is Professor Emeritus of Business and Public Policy at the Wharton School of Business, University of Pennsylvania. Hal J. Singer is a Managing Director at Navigant Economics, and has served as adjunct professor at the McDonough School of Business at Georgetown University. Both are consultants to the wireless industry. The opinions expressed here reflect the views of the authors rather than the views of their associated institutions.