TCS Daily


Glassman Testifies That Tauzin-Dingell Will Hasten Return of Re-monopolization, Re-regulation

By James K. Glassman - June 5, 2001 12:00 AM

Statement of
James K. Glassman
Resident Fellow, American Enterprise Institute
Host, www.TechCentralStation.com

"A Dangerous Fantasy"

Legislative Hearing on HR 1542
The Internet Freedom and Broadband Deployment Act

Committee on the Judiciary
United States House of Representatives

June 5, 2001

Mr. Chairman and members of the committee:

Thank you for inviting me here today to share my views on the Internet Freedom and Broadband Deployment Act of 2001, also called the Tauzin-Dingell bill, HR 1542.

My name is James K. Glassman. I am a resident fellow at the American Enterprise Institute for Public Policy Research in Washington and host of TechCentralStation.com, a website that focuses on matters of technology, finance and public policy, including telecommunications. I have also been deeply involved in issues involving financial markets in my longtime role as a syndicated columnist for the Washington Post as well as for the Reader's Digest and the International Herald Tribune and in my capacity as a frequent contributor to such publications as the Wall Street Journal, the Washington Times and the Atlantic Monthly.

Kill Competition, Damage the Economy, and Introduce Re-Regulation

Let me get immediately to the point: HR 1542 is being promoted as a way to boost deployment of high-speed data services. In fact, it will produce the opposite result. It will severely harm prospects for sustainable and effective telecommunications competition - and it will further deter the deployment of broadband Internet technology and do substantial damage to the U.S. economy as a result. You cannot have real consumer choice and the benefits that flow from it without competition, and you cannot have competition without competitors. HR 1542 would eviscerate the crucial provisions of the Telecommunications Act of 1996 that have created the competitive local exchange carrier (CLEC) industry and, make no mistake, kill that industry - kill the competitors, both current and future.

Furthermore, the bill, which is being presented by some of its sponsors as "deregulation," will actually produce re-regulation. I have devoted much of my professional career to advocating deregulatory, free-market solutions to economic and social problems. I know deregulation when I see it, and the Tauzin-Dingell bill is not deregulation. For reasons I will explain below, it will take us back to the pre-1984 days of heavy telecommunications regulation.

With the last of their CLEC competitors destroyed by this legislation, the monopoly Bells will expand their monopolies. This appears to be what some in Congress want. They assume that if we will trust benign monopolists, they will bestow wonderful benefits on American consumers. This is a dangerous fantasy. We tried it before, and it doesn't work.

In fact, the mere prospect of the passage of HR 1542 and its predecessor last year has already severely damaged the CLEC industry by helping to cut off the flow of investment capital. I did not come to this conclusion lightly. Instead, it is one of the preliminary findings of a series of studies that I am in the process of completing with two distinguished economists, Kevin Hassett, resident scholar at the American Enterprise Institute, and William H. Lehr, associate director of the Internet and Telecoms Convergence Consortium of the Massachusetts Institute of Technology. I am not saying that Congress should not discuss Mr. Tauzin's bill. I am saying that, by increasing the possibility of such legislation becoming law, Congress is unwittingly aiding in a strategy to kill the competitive telecommunications industry in its cradle and to deny to their constituents the benefits of high technology at a reasonable cost - the same kind of benefits that competition has brought to such sectors as computers (which have fallen in price, adjusted for quality, by 90 percent in 10 years), software and, in fact, long-distance services. Think of it this way: If you were a big lender or equity investor, would you devote capital today to CLECs threatened with annihilation by HR 1542? I don't think so.

HR 1542 will not deregulate telecommunications. Instead, it will undeniably do the following:

First, it will allow the monopoly Bells to crush their remaining CLEC opposition and extend their monopoly from end to end: from local service to long distance to fast Internet connections, or broadband.

Second, it will lead us straight back to remonopolization and re-regulation - back to the conditions that existed before the breakup of AT&T in 1984. If the Tauzin bill becomes law, and the Bells, as expected, eviscerate their opposition by leveraging their local monopoly, you here today know as well as I do that Congress will not stand by and allow such a powerful monopolist - either a single company or four regionals, or somewhere in between - to set prices, quality and extent of service. Congress will step in, as it should, with strict mandates. We will be right back where we started. Already, we have seen an amendment added to HR 1542 in the Commerce Committee's markup that sets a deployment timetable. All I can say is: Here we go again. Perhaps it is well-intended, but the Tauzin-Dingell bill is an act of re-regulation, not de-regulation.

Background: Slow Rollout of Broadband

Before I examine the specific deficiencies of this legislation, let me first offer some background: Today, barely 5 percent of households have even the most rudimentary form of broadband - or fast access to the Internet. As a result, the promise of the Internet is not being enjoyed by 95 percent of Americans - an increasingly frustrated group. Incredibly, in the first quarter of this year, for the first time ever, the number of Americans with Internet access of any sort actually declined. As Francis Rose wrote recently in Wired magazine, a monthly magazine that is a kind of non-partisan high-tech bible: "The digital future has arrived, but the analog past won't let go. Data flashes across the country at the speed of light only to end up dribbling out of your wall in the tech version of Chinese water torture."

Most Americans with Internet access have dial-up 56K modems even though the technology is readily available for speeds averaging 20 to 30 times that fast, using manipulations to the copper wiring entering your house - a process called DSL. But for lack of consumer access to DSL and other technologies, companies all up and down the line - from firms that wanted to deliver video down these pipes to companies that provide the infrastructure -- are stumbling and falling, watching their stock prices plummet, failing at gathering more capital, and filing bankruptcy. Since November 1999, some 25 CLECs have filed for Chapter 11 protection. Copper Mountain, a leading DSL equipment maker, has seen its revenues plummet. In the first quarter of 2000, its top four customers (NorthPoint, Rhythms, DSL.net and Lucent) spent over $50 million, but in the first quarter of 2001, the remaining companies in this group spent only $1 million.

"All this year, victims of the 'tech wreck' have been looking furiously for someone to blame for their huge losses," wrote Ethan H. Hugo of David L. Babson & Co., a Cambridge, Mass., investment management firm, in a recent letter to clients. "Pick your scapegoat:... greedy Wall Street underwriters and their cheerleading analysts, even Alan Greenspan. We suggest another culprit:...the growing pains and slow adoption of residential high-speed 'broadband' Internet access. This is the business factor that has been causing so many shattered dreams in tech-land."

And the problem is not merely declining stock prices and unemployment in the telecom and Internet sector. The problem is the overall decline in the U.S. economy - from a Gross Domestic Product growth rate, in annual terms, of more than 5 percent a year ago to barely 1 percent today. One of the preliminary results of the Glassman-Hassett-Lehr studies is that a key contributor to the slowdown in the U.S. economy is the slowdown in the dissemination of broadband.

The Bottleneck That Has Held Up Deployment

What is holding up the deployment of broadband? The answer to that question is not difficult to discern: There is a bottleneck at the "last mile" - at the local connection between high-speed long-distance data lines and the homes and small businesses of America. The Telecommunications Act of 1996 was supposed to loosen that bottleneck and at the same time spread the blessings of consumer choice and competition throughout the telecom system.

The idea behind the act was a sound one: The extensive local networks owned by the Bells had been built over decades and represented billions of dollars in sunk investments, much of which had been subsidized by a variety of implicit and explicit public-subsidy mechanisms. In the face of an entrenched and uncooperative monopolist, local competition faced barriers to entry that were simply too high, outside of a few major metropolitan areas. Without being able to interconnect to the incumbent's local access facilities on an equivalent, non-discriminatory basis, a CLEC was unable to offer a competitive product to establish itself in the marketplace. So, the Telecom Act of 1996 mandated that the Bells unbundle their networks and provide resale of all retail services at non-discriminatory, cost-based wholesale rates and that they also negotiate interconnection agreements for reciprocal traffic.

Of course, the Bells had a huge incentive to be uncooperative. They didn't want the competition. The Act provided a carrot: open up your local networks to competitors sufficiently and, on a state by state basis, you will be granted interLATA relief - that is, you will be allowed into long distance. This was a sensible deal for all parties and a good way to move toward what Congress and the president wanted: deregulation and the benefits - in lower prices, higher quality and broader dissemination - that competition had already provided in long distance and equipment markets, which the Bell System monopolized before its structural separation in 1984.

The Birth of an Industry

The Telecommunications Act of 1996 produced the birth of an industry - the CLECs. Some 300 companies exploded onto the scene, and investment in telecom infrastructure soared. Bells, which had kept DSL technology on the shelf for 10 years, suddenly began to deploy it in the face of competition, cutting prices to lure customers. "The Bells are not known for their competitive vigor," said an editorial in Business Week. "Indeed it was only competition from new companies that spurred them to start."

But despite that encouraging beginning, the Act has not provided the results that were envisioned. The incumbent carriers - the seven regional Bells plus GTE - have now become just four companies through remonopolization. They're now called, aptly, "mega-Bells" by the media. They serve 95 percent of the U.S. small business and consumer market and own 91.5 percent of all lines in the country. In only five of the 50 states have these Bell companies complied with the act to the extent that they have been permitted into long distance.

The Bell monopolies were fined over $370 million in 2000 for anti-competitive business practices, service problems and failure to live up to legal obligations. At every stage along the way, the Bells sought to overturn or weaken the pro-competitive provisions of the Act. They immediately appealed the FCC's first order establishing the economic standard to be used to set cost-based rules for unbundled elements on the grounds that the commission had overstepped its jurisdiction. The lawsuits and the foot-dragging continued. Wrote Mr. Rose in Wired: "The Telecommunications Act of 1996, which was intended to end the Bells' monopoly on local lines and transform the industry into a competitive free-for-all, has proved toothless."

Immediate Entry Into the 'Good' Part of Long Distance

An obvious remedy, therefore, would be to give the Act some teeth. Instead, HR 1542 proposes the exact opposite course. Incredibly, it removes the one incentive - in the absence of tough enforcement - that can encourage the Bells to open up their local networks to competition. That incentive, of course, is long-distance authorization. Let me again quote Mr. Rose of Wired magazine:

"The Bells' goal is to satisfy their customers' telecom needs in one package. But, so far, they've been allowed to offer long distance in only four [now five] states...because they haven't met the criteria set out in the Telecom Act. So while they stall on the local loop, the Bells have lobbied Congress to give them long distance anyway - not long distance voice, which is no longer a fast-growing market, but long distance data services, which are exploding." In fact, according to Telcordia Technologies, data represents about 75 percent of all network traffic, up from 50 percent in 1998. By 2004, data will be nine-tenths of traffic, voice just one-tenth.

As an editorial in the Los Angeles Times on April 27 stated: "The 1996 Telecommunications Act, meant to bring competition into local phone service, clearly hasn't delivered. Most consumers have no choice but to pay high prices. Reps. W.J. (Billy) Tauzin (R-La.) and John D. Dingell (D-Mich.) say they intend to fix this by allowing the Baby Bells into the long-distance DSL business while keeping their local-service monopoly. It is a proposal without logic. The change would only strengthen the Bells' chokehold on local service and remove any incentive to compete and innovate."

Think of long distance as the carrot - the only enticement, really - to get a donkey to move in the right direction, that is, for the Bells to act in a way that enhances competition and helps consumers. Think of HR 1542 as a law that orders the carrot to be fed to the donkey. The law, then, will stop the donkey in its tracks, that is, end the chances for competition that will help consumers.

Already, it should be noted, there are no regulatory impediments to the deployment of DSL by the incumbent Bells. Indeed, they are already deploying DSL -- without the Tauzin-Dingell bill. SBC, to name just one Bell company, announced it is spending more than $6 billion on "Project Pronto," a program to get DSL to millions of customers. BellSouth's Duane Ackerman has stated that his company "invested $33 billion...during the 1990s" and that it expects "total DSL revenue of approximately $225 million this year and $500 million in 2002. Mr. Ackerman, at a Salomon Smith Barney conference in January 2001, admitted that the regulatory challenges BellSouth is facing "are unlikely to slow down the momentum of the marketplace."

By letting the Bells immediately into long distance as a way of speeding broadband to consumers, the bill tries to solve a problem that doesn't exist: the Bells can already get broadband to consumers.

The Bill Turns Back the Clock to Before a Key Supreme Court Decision

But the bill is even worse.

It would overturn several FCC decisions since January 1, 1999, that give CLECs access to the network elements necessary to provide consumers with advanced communications services. Under the FCC's existing rules, the incumbent Bells are generally not required to share packet-switching equipment used for advanced services. The bill would expand this exemption to cover any network elements identified as essential to competition since January 1999, to the extent they are used to provide advanced services. The January 1999 date is significant. It was in January 1999 that the U.S. Supreme Court ruled decisively against the incumbents' challenges to the FCC's unbundling rules and upheld the FCC's authority to specify which network elements should be available to competitors. Subsequently, using the "necessary and impair" standard in the 1996 Act, as the Supreme Court required, the FCC added to the list of network elements that incumbents must make available for purchase.

HR 1542 rolls back the clock by fixing the list of network elements as of January 1, 1999 -- before the Supreme Court remanded the list to the FCC and before the FCC revised it as the Supreme Court directed. In effect, the bill hands the incumbent Bells the victory decisively rejected by the Supreme Court and rewards them for their refusal to comply with the requirements of the 1996 Act.

As the incumbents update their networks and replace more and more of their copper facilities with fiber optics to deliver high-speed services as well as basic voice, an increasing portion of those networks will become inaccessible to competitors. Ultimately, there could be little, if anything, left of the statutory mandate for the incumbents to give competitors access to unbundled network elements -- even loops, which are the critical "last mile" that competitors simply cannot do without.

In essence, the bill would effectively close the most significant door to competition under the Act by enabling incumbent carriers to avoid the fundamental obligation to open up their networks to new entrants. In a direct reversal of the requirements of the 1996 Act, it would preserve, exclusively for the incumbent carriers, the economies of scale, scope and density that they have built on the backs of the ratepayers

Study Shows That Just Consideration of Bill Impairs Capital

HR 1542 and its predecessor, HR 2420 last year, are so clearly destructive of potential competition that that the very progress of the bill itself has done terrible damage to the market capitalization of CLECs. In our research, we conducted what are called "event studies," looking at the market-price response to specific events that improved potential for passage of the Tauzin-Dingell bill or its earlier siblings. We found that CLEC prices fell significantly and repeatedly on those occasions, providing empirical evidence (as if any were needed) that markets believe that HR 1542 will destroy, not just competition, but competitors.

All of us in this room are aware of the decline in stock prices since the spring of 2000. Between March 1, 2000, and April 30, 2001, the Standard & Poor's 500-Stock Index, the prime benchmark for the U.S. market as a whole, fell 9 percent, and the PSE Technology Index fell 35 percent. But our research found that an index of CLECs fell more than 80 percent. Remarkably, we discovered that almost half of that decline was concentrated in the handful of days when the market learned that this bill or its predecessor was more likely to pass. A rich academic literature shows that capital investment for companies and sectors is tied to the direction and extent of market capitalization. We can expect, then, to see a sharp decline - probably in the 80-percent range - in capital investment by CLECs in the near future. This decline has already begun, with capital investment by all telecommunications companies falling in the first quarter of 2001 compared with a year earlier. It can only be reversed by wiping out the possibility of passage of a bill such as HR 1542.

This is my main concern. What I care about is the U.S. economy and the standard of living of average Americans, and what I know is that competition and deregulation produce better results than monopoly and regulation. This bill kills competition by killing competitors, and it will lead to more regulation, not less.

William Kennard, who served as FCC chairman from 1997 until early this year, called HR 1542 "a prescription for disaster.,.. You'd be telling Americans, 'Forget about having competitive choice for DSL service - We're going to give it to the incumbent monopolists.'" He also said, "This bill moves us 180 degrees in the wrong direction." Reed Hundt, who served as FCC chairman from 1993 to 1997, explains why capital has dried up for the competitors. "Investors no longer know the direction of policy," he told Bloomberg Business News recently. "They no longer know what to bet on so they are taking their money off the table."

The high level of uncertainty introduced simply by Congressional consideration of HR 1542 is exactly the type of force that squashes investment. Moreover, it raises the possibility that the Bell monopolies are purposefully lobbying heavily for bills such as this one because they are well aware that uncertainty about those changes can itself accomplish the job of slowing CLEC investment. Because of their smaller size and greater need for financial resources, CLECs suffer disproportionately when regulatory uncertainty contributes to raising the costs for financial capital. That is one of the preliminary conclusions of our study, but common sense would indicate its truth.

Fundamental Question: Trust the Monopolist? Or Trust Competition?

Mr. Chairman and members of the committee, the stakes are extremely high. The rise of the Internet, e-commerce, and the Bell mega-mergers have changed the communications landscape since the passage of the Telecommunications Act of 1996. The principle behind the act was sound. But it was flawed. As Nicholas Economides, a New York University economist, has said, "It didn't have the deadlines and punishments to make people do what they were supposed to do." Two bills introduced by Reps. Cannon and Conyers and their colleagues, HR 1697 and HR 1698, help enforce the Telecom Act through a reaffirmation of antitrust policy.

This hearing poses a fundamental question. What is the best way to accelerate the deployment of broadband technology? The Bells say that if you will relieve them of competitive pressures, they will roll out broadband faster. This is a paternalistic game that might be called, "Trust the Monopolist." Just give us back our monopoly power, and we will work wonders.

Nonsense. Competition, not monopoly, offers a far better guarantee that new technology reaches all Americans. Time and again, Congress and the president - across partisan lines - have trusted competition. And it has been the right course. The order to break up the Bell System in 1984 was an action that trusted competition - and prices fell and quality rose. Again, in 1996, Congress decided to trust competition, and it was right. This bill would undo that decision and would instead trust monopolies. That it why it is wrong.

The bill will do great damage to the economy and to consumers. In fact, it already has. It is time to reject a course that turns back the clock and hurts all Americans.

Thank you.
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