TCS Daily

A Telecom Tutorial for George Gilder

By Laurence J. Kotlikoff - March 15, 2004 12:00 AM

One of the nice things about economics is you don't need a degree to discuss the subject; nor do you need any credentials for people to listen. Indeed, if you write well and speak clearly, people will listen simply for lack of anything better to do. This will reinforce your own belief that you know what you're saying. And if you're a particularly smooth talker and attract a really large following, you'll end up with the ultimate prize -- guru status.

George Gilder is a guru of the first order. A politics major at Harvard, Gilder learned from none other than Henry Kissinger how much one can enjoy the sound of his own voice. After discovering the problem with single men (they're single), the cure for poverty (the workhouse), and inventing supply side economics (set taxes to zero to maximize revenues), Gilder moved on to his life's calling -- picking technology winners. Most of Gilder's stock picks headed into oblivion in the 2000-2003 tech crash. But, hey, who's counting?

In the current debate over telecom policy, Gilder has again picked his winners -- the four huge regional Bell operating companies -- and this time, he's using his pulpit, the Wall Street Journal's editorial page, to make sure that happens. Gilder's latest pronouncement on this topic -- "Stop the Broadbandits" (WSJ, March 4, 2004) -- would bring tears of joy to an English teacher for its flawless prose, but grimaces from any professional economist who understands the issue.

The issue is simple once one cuts through the details and telecom jargon. It boils down to the attempted monopolization of a public good. Public goods are non-rival in their use. The streets in front of our homes are a good example of a public good. All manner of friends, relatives, and delivery services can and do use them pretty much at the same time. No one in her right mind would suggest, for example, that Domino's Pizza should have to build, or actually could build, its own road to our homes rather than use the existing street to deliver us pizza. And no one, not even George Gilder, would propose giving Domino's Pizza a monopoly on the use of our streets.

Consider what would happen. On day 1, Domino's would levy a sky-high street-usage fee on all other pizza delivery services. On day 2, after their competition was history, Domino's would jack up the price of pizzas. On day 3, Dominos would go into the Chinese food delivery service and make sure no other Chinese restaurants could deliver wonton soup over our streets. On day 4, Dominos would boot out the U.S. Postal system, Federal Express, DHL, and UPS, and announce its own mail delivery service.

Who Owns the Lines? You Do

You get this picture. Now think about the local phone system, by which I mean the telephone wires, polls, underground conduits, and switching systems that connect us to the outside world. This system is also a public good. It has a huge amount of excess capacity. Hence, its use is largely non-rival. Given that, reproducing such a system would, to use an academic expression, be utterly stupid. Imagine having MCI, AT&T, Sprint, Verizon, SBC, Qwest, BellSouth, etc. each put up its own set of telephone polls down our streets!

The local phone system is not only a public good, as defined by economists, it's also a public good as in who paid for it -- the definition understood by everyday folk. Whether the regional Bell companies and their lobbyists want to hear this or not, the local phone system is not their property. It belongs to the public, having been built over the last century at enormous public expense. True, the federal government never directly paid for the phone system. Instead, it licensed a single company -- the Bell Telephone System -- to construct this network by charging the public phone rates far above the actual marginal costs of transmitting calls and guaranteeing the Bells an essentially risk-free return.

In 1983, in a landmark decision, the courts broke up the national Bell monopoly into a long distance company -- AT&T -- and a number of regional "Baby" Bells. The Baby Bells were given the right to run our local phone systems, but under strict regulation. This was like giving Dominos the right to repair our roads as well as sell us pizza deliveries, but at a regulated price.

The goal of the 1983 breakup was to foster competition in the long distance and equipment markets where it seemed most feasible. In long distance, the method was to force AT&T to lease its long distance phone lines to competitors, pending the competitors developing their own long distance phone facilities.

The reform worked incredibly well as measured by the extraordinary drop in long distance rates. Indeed, the reform was so successful that Congress passed the Telecommunications Act of 1996 (TA96) to do the same thing for the local phone and higher bandwidth markets. The regional Bells were required by the Act to lease to competitors, again at regulated cost-based rates, the use of our telephone lines, polls, conduits, and switches.

Unlike the long distance market, where it is relatively easy and efficient to run wire between major cities alongside rural railroad tracks or transmit signals with microwaves, in most local markets reproducing the "last mile" telecom pipeline turns out to be prohibitively expensive. This explains why there are no competitive local exchange carriers (CLECs) setting up extra telephone poles down our residential streets. On the other hand, CLECs have been doing all manner of other investment and hiring to service their local phone customers, including constructing their own pipelines in dense business districts.

Does the CLECs' inability to replicate the last mile represent a failure of TA96? Not at all. CLECs now service over 25 million household and business local voice and DSL lines. While a good number of these lines serving large business customers are provided over 100 percent CLEC-owned facilities, 19 million of these lines ride over last-mile facilities leased from the Bells. And thanks to competition by the CLECs, local phone rates have declined by as much as 30 percent in many parts of the country. Broadband rates are also on their way down. This is why the Bells are howling so loudly. They are feeling our joy.

Lest you are feeling sorry for the Bells, know this: The Bells received an enormous bribe to play ball with TA96, namely entry into the long distance market. Today, all four "baby" Bells are offering long distance service to essentially all their local phone customers -- and they have already garnered over a 30 percent market share. And they are primarily doing so by, get this, leasing existing long distance transmission services from existing carriers.

But what's good for the goose is apparently no good for the gander. Now that the Bells have gotten their end of the bargain, they are working overtime to renege on their obligation to provide CLECs with leased access to our local phone system. Indeed, their game plan is to a) eliminate all local phone competition and b) wipe out long distance and cellular competitors by marketing a telecom bundle consisting of local voice, long distance voice, cellular, and broadband, in which the latter three products are thrown in essentially for free. Need proof? Just check out Verizon's "Freedom Plan," which it's marketing throughout New England.

Since essentially everyone needs local voice service, absent TA96 the Bells' competitors won't be able to offer a competing bundle and will be forced out of business. Hence, if TA96 is overturned or otherwise vitiated, the Bells will achieve their dream -- complete monopoly control of voice transmissions and a duopoly, with the cable companies, in broadband.

Planet Gilder

This is the world we live in. George Gilder, in contrast, lives on a different planet. George begins his March 4th op ed by claiming that TA96 was designed to deal with "long-gone" monopolies. The facts speak differently. Notwithstanding significant CLEC inroads, the Bells still dominate the local market, servicing over 85 percent of all local voice and DSL lines. Verizon is already the nation's third largest long distance provider, despite the fact that it only markets to customers that are in its local service footprint. And, with Cingular's recently announced acquisition of AT&T Wireless, Verizon and SBC/BellSouth (Cingular) are our nation's two largest cellular providers. Furthermore, the reason the Bells aren't able to fix price is precisely because TA96 is working, not because it's irrelevant.

Second, Gilder contends that implementing TA96 "devalued all investment in new infrastructure..." thereby killing the network equipment industry. Nothing could be further from the truth. TA96 triggered a huge expansion of investment. Indeed, since the Act was passed, the Bells and the CLECs combined have substantially increased their telecom capital spending, with the cumulative increase relative to trend totaling roughly $100 billion.

Yes, the last recession was particularly tough on the equipment sector. But, in the run up to the recession, the Bells killed off many of their CLEC competitors (and their demand for equipment) by doing their level best to impede implementation of TA96. The fact that the remaining CLECs are now starting to grow their local voice market share and reinvest in telecom equipment is testimony to the fact that both the FCC and state PUCs are finally starting to enforce the act.

Gilder's third mistake is believing that, given an unfettered monopoly, the Bells will run fibers to every American's home making broadband ubiquitous. He seems to forget that, as you read this, tens of millions of American households can easily order broadband and aren't doing so for one and only one good reason. It's priced too high. And the only way to guarantee the much lower consumer price needed for much wider broadband adoption is to promote broadband competition. Who, but Gilder, ever heard of a monopolist voluntarily cutting price at the cost of profits?

Gilder's fourth and most malevolent assault on the truth is his suggestion that FCC Commissioner Kevin Martin was siding with the forces of evil in voting with his Democratic colleagues in February 2003 to enforce the competitive promise of TA96 via a new set of leasing rules. This vote, in the face of enormous pressure by the likes of Gilder, was Kevin Martin's finest hour -- a true profile in courage, the likes of which is rarely seen in Washington.

Unfortunately, the telecom wars continue. Less than two weeks ago, the DC Circuit Court of Appeals Court overturned the FCC's new leasing rules, which had been carefully crafted to satisfy both TA96 and the DC Circuit's own prior instructions on implementing the Act. Even worse, the ruling gives the FCC only 60 days to come up with a new set of rules. Since it took the FCC well over a year to come up with the existing set of rules, the Court is, in effect, trying to vacate not just the FCC rules for implementing the Act, but the Act itself.

At this point, the only real hope of keeping our telecom street open to all delivery services is for the Administration to appeal the Circuit Court's ruling to the Supreme Court and for the Supreme Court to reverse the Circuit Court's decision. Let's pray that the Administration takes that step in support of competition and that the Supreme Court delivers us from the clutches of a bunch of very greedy monopolists and their apologists.

The author is Chair, Department of Economics, Boston University and serves as a consultant to AT&T.


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