American Telecommunications Policy At the Crossroads

Eli M. Noam
Columbia University
April 26, 2001
Bad Honnef, Germany

In discussing the future of telecommunications regulations one needs to ask first, there is a future? Or is it just the same present and past repeating themselves, like in the movies, just like in the movie Groundhog Day, where Bill Murray was condemned to live the same day again and again? It’s been over five years now since the Telecommunications Act of 1996. And yet, it seems like the old days, everywhere in new variants one looks, one meets dear old friends. There’s Interconnection, for example, and over there, RBOC long-distance service and universal-service depressed as ever. And here is good old state jurisdiction. Among such trusty companions, does one dare to speak of the future as anything but a continuation of the past?

We find ourselves today in one of those great divides of economic history, where we can either go forward into the unknown, or go back, with a sigh of relief, to familiar territory. The new economy—new style telecom entrants, new media companies, e-commerce sites etc.—has become an old-style bust. The adults are back in charge. Legacy is in. Balance sheets are in Blue chips are in. We need not listen anymore to the purveyors of hype, about how bits play by different business rules than atoms, how the silicon economy is different from the carbon one, and how a P/E ratio need not have any E that stands for earnings, as long as that e-stands instead for electronics.

All this was mostly hot air, but its promoters had success and riches as their unassailable arguments. And where were the controls to irrational exuberance, the serious journalists, the academics, and, above all, those allegedly rational financial markets?

Out of the great inspiration for the hot air was the posing, in 1996, of the Telecommunications Act. It led to great expectations and great hype. Today, five years later, we can observe its impact.

We should take this Act very seriously. But precisely for that reason my conclusion is: the Act made no big difference. Yes, the passing of 5 years of time made a difference, but if we had no Act, the combination of FCC, PUCs, smaller pieces of law, Congressional pressures, Judge Greene and other courts, would have reached pretty much the same results, Act or no Act.

On the margin there were some pluses. But if you look at the whole picture, the 96 Act is merely a pimple on the nose of the digital revolution. The Act is the result of change, not the cause of change.

What are some of the things that either did not happen, or happened, regardless to the Act?

Investments. Telecom stocks, like other tech stocks, generally went up, and then they generally went down, like the rest of tech stocks. It didn’t take an Act. For a while, all these investment bankers and fund managers kept repeating to each other that competition would unleash profits. What this overlooked is that usually it’s companies with market power that are profitable, like Intel or Microsoft, rather than small businesses competing in a commodity business, like long distance entrants. But now elementary economics sinks in, and Wall St is rediscovering its soft spot for the big incumbents.

The second thing that Wall Street kept repeating was that the Act would create greater certainty. Oh, Really? Throw a law of 300 pages, that papers over many divisions among the numerous hostile industries and companies, in a high-change, high stakes, dynamic industry sector, into an environment teeming with Washington lawyers, an FCC commission with more egos than expertise, more courts than even in Florida after an election, 51 touchy state commissions, and you expect certainty?

Actually, the fastest growth of investment had been in 2 areas left alone by the Act, Internet and wireless. The whole Act mentions Internet only once seriously, and then in a way that has not withstood Sup Ct. review. That was on the issue of child-proofing the IN, which was just about the only issue that the public ever read about the bill during its drafting process. The rest just wasn’t much news to normal people and was seen more of an intra-industry fight.

When the Act was finally passed, the White House. Congress, Washington lobbyists, and journalists together created the impression that the law had created local competition, whereas in fact is was merely a step –through an important one in the opening of local markets to competition, a process that had been pushed for years in many of the economically more important states like New York when I was a commissioner there. 

What has been the state of local telecom competition? 

As mentioned, such competition had already been happening before the 96 Telecom Act. It would have continued apace after 96.

Local competition is the key to liberalization. But it has been largely unsuccessful for the residential market. 

All this creates a window of opportunity to major mergers. In a fairly short time, we might therefore be looking at 3 or 4 ILEC companies, vertically integrated into long distance, owning the major long distance companies, plus most wireless, and ISP backbones. This would be a major restructuring of the industry. Comparable only to the AT&T divestiture almost 20 years ago. 

What then is the future? 

We can assume simply that the technology in 20 years isn’t radically different, just cheaper, smaller, faster, and spread through society. Basically every communications device we have today existed 20 years ago, just bigger, clearer, slower and without the network externalities of a large user base.

But these trends, of cheaper, faster, smaller and widespread exponential at present, add up to a lot of change. For example, if you believe the growth scenarios of e-commerce companies the way Wall Street does, we will have in 2020 half of the population employed as web masters, and the other half driving UPS delivery trucks.The basic building blocks of technology are not many.First, there are semiconductor transistor chips such as microprocessors, memory, and signal processors.Next year, the world will produce about 100 trillion transistors, thousands of them crammed on silicon wafers.If Moore’s so-called law keeps valid, by the year 2020 these chips will have 1,000 times more power than today, or be 1000 times cheaper, or a combination of the two.

Now the tables are turned. Now the New Economy types are the butt of a global and gleeful outpouring of schadenfreude.

Costs are high, and retail prices are low. Cable TV and cell phone companies are the most promising entrants, because for them the residential voice service is an incremental business, and costs are therefore incremental only.

Competition to cable? There is no more cable competition that in 96. The exception is DBS, and it is unrelated to the Act.

The Internet. The IN, touted as exhibit A for the benefits of keeping government out, was actually the creature of government. 

Wireless has grown enormously, but not because of the Act. It’s growing in Cambodia, too. In fact, the US is behind its international peers. Whatever happened was initiated already before 96. 

Deregulation. Deregulation was really a false promise. Break open the new, i.e., demonopolize , and deregulate at same time, are inconsistent, at least for a considerable early period. So we got those wordy FCC orders, half of them sent back by the courts anyway. FCC had powers to forebear from some regulations, but did not do so. This system became highly complicated, with new unbundling, forward-looking pricing, resale discounts, collocations, and much more, with no relief in sight. 

What happened was that Congress enshrined the suspicions of decades of divided government into legislation, and those provisions, while maybe reflecting the equilibrium of yesterday, are becoming the disequilibria of tomorrow, and very hard to change.

The other reason for Congress to seize control was that it recognized that becoming the arbiter rather than delegating this to a bunch of FCC bureaucrats and judge Greene could be a very lucrative opportunity for increasing their clout and coffers.

Thus, one cannot say that there is less government regulation than before 96. The opposite is true.

Greater efficiency. Interconnection Pricing moved more to a cost based arrangement, both through incremental cost methodology and the move to flat rate charges. These things were part of a trend of many years, and would have happened anyway, as the CALLS compromise shows. 

Connectivity of classrooms. The E-rate program has accelerated connectivity of classrooms, but this connectivity would have happened anyway, just more slowly.

Overcoming the digital divide and other aspects of universal service. Domestically, the Digital divide is being resolved, largely by itself, plus a more judicious and less political interpretation of the same numbers. Internationally it’s a different story.

Internet connectivity will cease to be a major issue, at least for narrowband, because IN will be freed from the tyranny of the PC.

I say this with great regret, as a supporter of competition in academia and as PSC commissioner. But we must look at facts objectively, in light of experience rather than desire.

In terms of demand, the network industry is doing terrifically. Everyone uses TC more than ever. Except that nobody seems to make money anymore. Local competitors are on the ropes. CLECs, DLECS, and BLECS are bleeding. Resellers cannot make it. Wireless providers are spending huge amounts on spectrum, infrastructure, and customer acquisition. DSL companies are bankrupt. Cable companies are the only ones with some presence, strong in cable modem BB, but weak in telephony, and weakened by AT&T’s disarray. Why everyone has been exaggerating the success of local concept.

Yet it would be tragic if incumbents would let the pendulum swing too far, use this breathing space for smug self-satisfaction rather than regrouping, retooling, and re-planning. The black ships challenging the old network may have retreated over the horizon, but they will be back. No temporary slowdown should obscure that we have just gone through something very fundamental.

Now that the dust is settling, what have we learned about the new network economy?

·The new network system is not linear but cyclical.

This is true for many industries, but it was never this case for TC.

The digital network economy is subject to severe shocks and discontinuities. The industrial revolution was not linear, either. There were recessions and depressions. In the 1830s, 1840s, 1870s, 1890s. Over-expansion is a hallmark of health, not weakness. Early railroads were vastly overbuilt in the US. One could take 12 different private railroad routes between NY and Chicago alone. There were hundreds of companies making automobiles, motorcycles, airplanes, and microcomputers. One of the functions of slowdown is consolidation. That is, to reduce competition. To reduce the co modification that lowers profitability and investments. 

To summarize the technical trends: The decade of the 90s was dominated by the revolution in processing power, based on fundamental VLSI technology advances of the 80s.For a while, transmission couldn’t keep up with processing, because it was much more expensive to widen the channels than to add the driver instead of the brake.

And what will be the impact of these trends?

The most obvious one is that prices drop. Transmission becomes commodity. MCI WorldCom’s winning bid for the Federal Government's FTS 2001 has a per-minute price, in a few years, of less than 1 cent per minute. Similarly, for international transmission, new projects will raise capacity was 5.1 Gbps in '94, 65 Gbps in ’99, and 865 Gbps in 2003 almost a quadrupling every two years. And that's without the adoption of the next round of innovations in fiber optics. As that happens, international calls become priced at flat rate, near zero. On an architectural level, networks become engineered for data, not voice, because data, which is now about 50% of traffic, will be 98% in a few years. Bandwidth becomes a substitute for switches. And with flat pricing, monthly phone bills that itemize calls will probably become unnecessary.

·It is difficult to do competitive telecommunications.

·Operations are difficult. Many systems need to be in place and integrated. Supply chain. Selling systems.

·Economies of scale are back.

On the supply side, fixed costs tend to be high, but the variable cost of spreading the service are relatively low, the classic attributes of "natural" monopoly with electronic tools, intra-company transaction costs decline. On the demand side, there are “positive network externalities” of having large user communities. Put these three things together –high fixed costs, low marginal costs, and network externalities-- and there are real advantages to being large.

And not only did the networks become big and fat, they also became dumb and dumber. That is, more and more of the intelligence has been moving to the periphery, to users and specialized value added providers, and away from network providers. The incumbent carriers have resisted this trend. They probably lost this war. But they stand to gain most from losing, because they are good in doing the bulk part of the business: provide a basic mass transmission networks, reaching every business and residence, and benefiting from their size. Let others do bells and whistles on top. 

The Networks become big, and dumb and dumber. That is, more and more of the intelligence has been moving to the periphery, to users and specialized value added providers, and away from network providers. The incumbent carriers have resisted this trend. They probably lost this battle. But they stand to win this war, because they are good exactly in doing the bulk part of the business: provide a basic mass transmission networks, reaching every business and residence, and benefiting from their size. Let others do bells and whistles on top. 

For a while, we could ignore these economies, because the inefficiency of the incumbents masked them, and provided an umbrella. But the inefficiency has declined with threats of competition, and now economy of scale and scope are back, and the small entrants are on the ropes. 

Entrants are on the ropes. Yes, part of it is that they being stymied by their supplier/competitor. But we should consider the possibility that the incumbents may be stronger for reasons beyond discrimination. And where does that leave policy? It would have been a dead end. Or, to phrase it more positively, a transitory policy for a transitional phase 

The implication is that

·Telecom Network markets will often be uncompetitive 

This is what this consolidation period is all about. To get out of the commoditization in which new companies were running on their financing rather than on revenues and cash flows is worked for a while, with stocks rising, and with the expectation that the new companies would be bought by the old companies for huge premiums. But now, some of the most likely buyers are slowing down, by their own actions. Telecom companies, for example, have mortgaged their credit rating for the licenses of 3G wireless and for international expansion, and have a more difficult time to be buyers.

·Traditional brands will still predominate.

When insecure customers brave into the new economy, they want to feel safe about the deal and the quality of the service, and whether that entrant will be around next week. People got when their DSL provider, Northpoint, went out of business. Established brands are trusted. New firms without strong brands will have to fine niches. 

The new tools

Thus it seems that the new network economy will not look so new, after all. But that would be the wrong conclusion, too. Just as in 2000 some people claimed that the old rules do not apply, we should now not conclude in 2001 that there is nothing new under the sun. To the contrary. The last few years have created a set of enormously powerful tools that have not even begun yet to transform the old economy.

Individualization. 

We are moving to 2-way interactivity, customer identification, customer-centric marketing customer self-segmentation, customized marketing, and customized production. All this challenges the basic concepts of the industrial age mass-production and mass marketing. 

Broadband Networks.

In the past decade, the Internet revolution was mostly driven by advances in bit processing technology. Transmission, in comparison, grew more slowly. But that is changing. We are reaching the end of the narrowband Internet as the driver of change. We are now engaged in the next stage, that of expanding to broadband. Networks are growing from skinny to fat. For George Gilder, the rate of transmission capacity increases twice as fast as Moore's law. That is, a doubling every year, or even more. We are moving from the kilobit stage of telecommunications to the megabit stage. Communications become largely distance and time insensitive, flat-priced, ubiquitous and always-on. A commodity. 

This capacity and price revolution has not yet been absorbed into economy and business behavior. It will enormously affect mass media and marketing. And the very structure of markets and of companies themselves. Firms will increasingly become networks, and integrators. Suppliers, producers, and distributions will cluster in networks. The workforce is distributed worldwide. Some of these networked relationships will compete with each other, others collaborate in meta-networks. The ability of firms to be part of networks becomes critical.

Machine to machine communication.

As processing becomes cheap, it will be anywhere. Computers and cell phones have started to be given away for free. People will be the minor part of information generators. We move from person-to-person to machine-to-machine communications. Data machines will be everywhere. The IP protocol will be in every device. Suitcases will complain to airlines. Electronic books will download from publishers. Front doors will check in with police departments. Pacemakers will talk to hospitals. Light bulbs will haggle with utilities. Television sets will download from video servers.

Increasingly, devices will communicate with each other and control business processes, bypassing the slow and unreliable human element for routine transactions. 

Mobility. 

Mobile communications operate at narrowband capacity. Despite the UMTS hype about wireless video etc, we’ll be lucky to get ISDN speed. And mobility is not a good environment for most transactions and content. We should therefore not over-estimate M-commerce as the savior for the laggards of e-commerce. At the same time, it provides geographic and temporal ubiquity, and, with adequate security provisions, a micro-transaction billing mechanism. In a next version of WAP it might also have an always- on connectivity, like I-mode in Japan, which is not a matter of higher speeds but of packetization and of a sensible billing arrangement. Always-on, everywhere, is a truly revolutionary development. Because it makes increasingly most people in the world totally connected to each other, all the time. And they will never go back and disconnect. Always-on mobility is also a tool that has not yet been really created and absorbed into the business process. 

Encryption.

Encryption translates into an ability to create micro-payment systems, which create the economic foundation for many new business activities. Advertising models, and subscription models have not worked. We need direct payment models like the rest of the economy. "If you cannot bill it, kill it" will be the test for many electronic transactions. Automatized micro-payment systems will create revenue streams that make business models possible. But so far, they have not been convenient, and have not been absorbed into business processes.

So far, we described new tools of the new economy that are mostly technical. But there are also institutional and psychological tools. These include

Financing Mechanisms

Vast institutional network of VCs, angels, incubators, investment banks, and exchanges has emerged around the new economy, and has created financing channels of risk capital of awesome magnitude. These investment changes will not go away.

·Mindset and style

The sociologist Max Weber showed us how mindset affected early 19^th century economic transformation. This is true today, too. The new economy is also a mindset. It has shown us what amazing things it can accomplish. But changing the culture and style of organizations is the hardest thing to change. Change management becomes a priority.

Old and new styles will not easily merge. We are only at the beginning here.

We have not seen yet the virtual organization, the network organization.

The telecom entrants might not be successful in the short term, but they have created an important legacy. Things are not back to normal.

1.They have forced the incumbents to shape up

2.They have created a regulatory structure that will permit competitors to come back, in a second wave.

3.They have created a mechanism for the financing of such entry

In such an environment of telecom plenty, what will be the nature of telecom regulation? The problem is that the future is always a bit of an inkblot test, into which everyone projects their fantasies, desires, and nightmares. When it comes to the Internet, some see education and democracy. Others see pornography and chaos. (It’s similar when it comes to)? And since so many have had some negative experience with government, one fantasizes of its demise. The knee jerk response is: NO. Thank you, Mr. Regulator; it’s been a nice long century together. But now, we’ve got the Internet!

Part of this is wishful thinking. It's a preference for return to the Garden of Eden before the apple and the Mackintosh, a hope for autonomy and self-reliance.

In the past, this notion of the withering away of the state has been held by Marxists and utopian socialists. Today it’s become the worldview of Silicon Valley billionaires (to be redundant who skipped history classes in high school).

Of course, some of the traditional regulatory agenda becomes unnecessary. Price regulation is not needed under a wide-open and widely competitive system. Neither is profit regulation, or quality regulation. Even interconnection and unbundling are important only where there is market power and bottleneck control.

I doubt that. And this isn’t because of some bureaucrats who cannot let go. Regulation exists in response to interest groups. Whether they are incumbents, entrants, consumers, rural residents, or large users. These interest groups will never disappear. And new ones will emerge.

1. Redistribution. In a democratic system, a majority always wants something from the minority. Many people believe that somehow the efficiency of competition will shrink the subsidy slice of the pie to zero. But that assumes that the definition of the pie does not grow. With telecommunications becoming ever more important, not having the right connectivity becomes a major disadvantage. That's why we hear about the info poor, the digital divide, the fourth world, the schools and hospitals, and that’s why we will expand our definition of what is covered. For example, Subcommittee Chairman Seen Burns announced that his legislative priority for this session is to accelerate advanced services and fiber to rural areas. This legislature does not seem to be exactly very deregulatory. And all this will be extended, in time, to DSL, cable modems, video server access, and mobile telephony. 

Part of the problem is that the old sources for subsidies are being competed away, while demands for new subsidies grow. In consequence, new ways to raise money and to cross-subsidize will inevitably be pushed.

This will be a major battlefield of the future.

2. E- commerce and consumer protection. In the past, the Internet confronted little resistance in the political sphere. It faced public fascination, and rightfully so. Eyebrows were raised over porn and privacy, both politically very correct targets of complaints. But, this will inevitably change. As the Internet moves from a nerd preserve to shopping mall and mass medium, it is unrealistic to expect that it will be treated differently than the rest of society’s transactions. Which means that it is unrealistic to expect it to be left alone.

Inevitably, there will be problems of fraud, misrepresentation, and theft. And therefore there will be pressures for consumer protective regulation.

Monopoly power.

Many people believe that issues of market power do not apply to the Internet, because it is so wide open that any dog can start it’s own business. We are told that the bit economy plays by different economic rules than the atom economy, that silicon-based transactions are different from this based on carbon, and similar nonsense. 

It’s unclear why packet switching would make Adam Smith obsolete. We might indeed observe that computer communication and market power have been kissing cousins for a long time: AT&T; IBM; Microsoft; Intel. Each of them deserves a chapter in any textbook on antitrust. And why should it stop here? Yahoo? AOL? Amazon.com? Are they the next chapters? Why not? Presumably, these companies are trading at such high levels because of investor expectations of abnormally high profits, not because of a competitive return. The economic logic is relatively simple. Development costs are high, marginal costs are low. So there are large economies of scale. Brands are important. First entrants have advantages. There are network externalities. The Internet may still have the image of small is beautiful, but the reality is changing fast.

Privacy Protection.

Before some people get upset, remember that the goal is not to stop national footprints. National footprints are good as long as they are not exclusive. They are better than regional fortresses, with their potential to be leveraged vertically. National footprints emerge in the wireless field despite a Byzantine auctioning system. Verizon, with its GTE properties, could be national presence. Qwest has CLECs around the country. SBC is under FCC obligations, and once they get 271 approvals this might become a business proposition.

Now if you drop structural policy, that is, control of the market structure, which has been the mainstay of Washington policy for decades, th3e question is what to do. The question for policy is: moving forward or moving back?

Moving back is to conclude that market power is here to stay, and to regulate it like in the old days, with some modern twists to hide that.

Moving forward means to push not just competition but competitors, by give entrants various advantages. And this also means regulation. It also means re-balancing rates in a fairly radical way.

Moving sideways is to step aside, end most regulation and let markets somehow establish themselves.

This is less likely. Not because of bureaucrats who cant let go. It’s because interest groups want something. What they want, most of all is some economic redistribution in their direction.

The second reason is that there is fraud and bad faith, though this needs not be dealt with through telecom bodies. And the third reason is that market power can be persistent and structural. Again, this can be dealt with through other bodies.

Because total deregulation is therefore less likely, maybe one should sunset sections of the Act. Now for 5 years from now. The probability is not the rules per se, but rather than entire industries grow under its umbrella, so you can never take the umbrella away. If people know that rules will vanish, they will hurry and create facilities.

The Next agenda

Let’s start with a popular item that will make very little difference.

FCC Reorganization. Any regulatory system is inherently slow relative to the issues of a dynamic environment. You can reorganize the FCC all day long and it won’t make much difference after some early Hawthorne effect except take much attention away.

It also requires a change in the allocation system, which right now is based on auctions. Which are based on the notion of exclusivity and ownership. This system has bled the wireless 8industry sector white and slowed its development. Its bad policy, bad economics, bad technology, and bad law.

Government in effect asked each company how much it was willing to pay in order to survive.

This is not to say that spectrum use should be free or given to the companies with the biggest campaign contributions or the best lawyers. Instead, we should move to a system of open and unlicensed access, where you pay for usage, not for ownership, like cars on the toll road.

We’ll also probably go to face calls for the inclusion of mobile service in universal service. And of rules to protect against wireless telemarketing and of abuse of location information. And we’ll face a lot of security problems with wireless hackers.

We’ll also encounter new issues. In Japan, which has a competitive wireless field, NTT DoCoMo has created, through its superiority in the instant messaging, network externalities that give it unbeatable advantage. It’s like the AOL instant messaging situation which the FTC addressed recently, and it will lead regulators to require cross-platform opening in order to establish competition. 

Principles and process

The recommendation for legislation is: Don’t take the bus. Avoid the omnibus. The omnibus law that tries to do it all, covering the entire electronic media in one big law or Christmas tree.

The genius of the American system of telecom reform has been in the past its instrumentalism. It's almost a Common law approach. No big battle, but small skirmishes. This was in contrast to other countries, which had big reform legislation that took decades to pass and were out of date from day one. America avoided that process, and opted for messy progress over an orderly snails pace. Until the 1996 Act.

So I do not wish for us to have a Telecom Act of 2006 that cleans up previous problems and creates new ones, as part of industry compromises of established players. But rather, any future legislation should reduce telecom law to a few broad principles. Areas declared out of bounds for regulation. And areas in which a commission should follow broad policy principles laid down by Congress. We should learn from controls in computers, where we have a hierarchy of control instructions. In societal rules, one should think of a similar hierarchy. 

Some regulation can also be undertaken by the industry itself, as self-regulation. But keep in mind that self-regulations historically almost invariably became an instrument for cartel behavior, and excluded the public interest. So self-regulations could be delegated by an FCC or state, subject to some policy principles, and subject to review. In other words, we should have regulated self-regulation.

Conclusion

The new network system is proving to have many similarities in its market structure and policy issues as the old system. But it has created important business tools, models, and styles that will endure in a new network economy. 

The new network innovators will supply the new tools, which is what they do well. With some exceptions, They will be functioning less as providers of outputs and consumer products because those are hard to run day in day out and require experience, management, and capital, as much as providers of vital inputs and innovative tools and processes. In other cases, they can package and market elements in novel ways, until traditional companies catch up with them. But on the whole they and their innovations will be absorbed into traditional economy firms, by acquisition or partnerships. In the process, competition will be less between new and old economy firms, but among traditional firms, based on their ability to absorb these new tools, optimize their processes, integrate their various activities, and streamline their relations with suppliers and customers. 

In the process, the new network system and the old network environment become the new new network economy. Less competitive than many hoped for, more competitive that the old Ma Bell. Regulatory policy will have to find ways to assure that the major companies become rivals rather than partners, and that future competitors will be able to enter rapidly. When price and cost conditions are right again, new entrants will again find opportunities, and, like MCI in the 1970s and 80s, shake the industry and, move Joseph Schumpeter's process of creative destruction of capitalism to its next level.

But he has not shown, in his speeches, as understandably of his choice.

We have almost reached the need of this process of the 96 Telecom Act.

It has not achieved its purpose. It has made more lawyers rich. But it has not established the key goal, concept in the lost bottleneck. In order to establish such concept, regular system created of great complexity.

Some people think that all we need is patience. I believe that we need to have a view strategy. And this is the roll of policy analysis and research. And this is why an organization like WIK is so essential.