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SEPTEMBER 2, 2002

Cable Access

Telecommunications was the driving force behind the great economic
boom of the late '90s. Between 1996 and 2000 the telecom industry
grew at twice the rate of the national economy. By March of last
year telecom companies had reached a market value of $3 trillion,
and their share of the national GDP had risen to almost 6 percent.
The Internet, and wireless and other telecom services, spurred
investment in information technology, which by 1999 accounted for
43 percent of private, nonresidential investment. To a great extent,
the boom of the late '90s was a telecommunications boom.By the same token, the bust of the early 2000s is being driven
largely by a collapse in telecom. The industry has lost an
estimated $2 trillion in paper value on the stock market--more than
eight times what it cost to bail out the savings and loan industry
a decade ago. New investment capital, vital for innovation, has
dried up. In the first six months of this year (i.e., before
WorldCom's bankruptcy) telecom lost 225,000 jobs, one-fifth of the
total jobs lost in the country. And with thousands of miles of
excess capacity in fiber- optic cable, and as much as $500 billion
in questionable debt, the industry may continue to hemorrhage value
and jobs for the foreseeable future--potentially imperiling the
country's overall recovery. Says former Federal Communications
Commission (FCC) chairman Reed Hundt, "If the communications sector
doesn't start attracting investment again, it's going to be hard
for business investment in general to increase. And if that doesn't
happen soon, the whole economy will begin to shrink again."

The government official most responsible for turning telecom around
is the current FCC chair, Michael Powell, son of Colin. Articulate
and well-liked on Capitol Hill, Powell was the first choice for the
FCC job of former Senator Commerce Committee chair John McCain and
House Commerce Committee chair Billy Tauzin. But Powell has proven
a disaster. He has equivocated, frustrating even ardent supporters
like Tauzin; and when he has finally acted, it has been to prolong
rather than shorten the telecom slump. Like Harvey Pitt, the
chairman of the Securities and Exchange Commission (SEC), Powell
would be ripe for replacement--if his feckless, ideological
approach didn't so perfectly reflect the president he serves.

By Powell's own admission, the key to reviving the telecom industry
is stimulating the growth and improvement of broadband--the
high-speed Internet connections that are widespread in business but
have only incrementally made their way into consumers' homes.
High-speed Internet connections--carried either over cable TV lines
or phone lines (called DSL, for "digital subscriber line")--could
speed the technological convergence between the phone, the
computer, and the television and spark new investment in hardware,
software, and infrastructure. As Powell himself stated in testimony
last month before the Senate Commerce, Science, and Transportation
Committee, "Broadband very likely holds the key for the long-term
recovery of the telecommunication industry, and indeed our nation's
long-term economic growth and its ability to compete on the global
stage."

But the growth of broadband is lagging. Eighty percent of businesses
connected to the Internet use broadband, but only 12 percent of
homes with Internet service do--not nearly enough to spark
widespread new investment. The reason is largely that prices for
residential broadband remain high. While other kinds of telecom
prices--from long-distance and wireless-phone rates to
super-high-speed oc-3 lines--have fallen, prices for high-speed
cable and DSL connections have actually risen. It costs between $40
and $50 per month for residential broadband, compared with just $10
or $20 for slower, dial-up modem connections.

Why have broadband prices risen while other telecom services are
getting cheaper? The answer can be found in the first chapter of
most economic textbooks: There is little or no competition among
broadband providers. In most areas, the cable company connects
residences to the Internet through the TV cable, and the regional
Bell company connects businesses through DSL lines. Cable and phone
companies rarely compete with one another, and both have
effectively discouraged Internet service providers (ISPs) like
MindSpring or EarthLink from using their connections. Cable
companies have often blocked other providers outright, while phone
companies have used a variety of tactics-- from getting local or
state commissions to set prohibitively high rental prices for their
lines to sabotaging rival systems by deceiving them about whether
Internet addresses were available. In Virginia, when one small town,
Bristol, wanted to set up its own broadband system, Verizon
lobbyists persuaded the pliant, Republican-controlled state
legislature to pass a law prohibiting any town from doing so.

In the older dial-up market, where prices have fallen, there are 15
ISPs for every 100,000 subscribers--everything from AOL to MSN to
the small start-up. These ISPs have been the source of innovations
like instant messaging. In the high-speed market, by contrast,
there are fewer than two ISPs for every 100,000 subscribers.
Affiliates of cable and phone companies have a 95 percent share of
the broadband market. That lack of competition keeps prices up,
demand down, and innovation at bay.

That's the short-run problem limiting broadband's expansion. The
long-run problem is that the high-speed services offered by the
cable and phone companies are still fairly primitive. During the
late '90s fledgling companies laid down high-capacity fiber-optic
lines between large cities and even across oceans, but phone
companies continued transmitting the "last mile" of
connections--i.e., from local hubs to individual residences or
businesses-- through slower, lower-capacity copper wires. This
isn't a problem for telephone conversations, which transmit a
relatively small amount of information at a slow speed. But it's a
major problem for broadband, which transmits huge bundles of
information and can be greatly slowed down by copper wires. Nor is
widespread broadband access over cable lines a solution: Like copper
phone lines, cable is a relatively low-capacity conductor, and the
speed of delivery slows dramatically as the number of users grows.
(If you subscribe to broadband through your local cable system,
cross your fingers that your neighbors don't follow suit.) To
achieve its potential, broadband providers need to "uncork the last
mile," extending fiber-optic connections to office buildings and
residences. But so far, the Baby Bells, which own the wires, have
proved reluctant to replace them. And why should they? Lacking
competition, they have little incentive to improve or innovate.

There are solutions to these problems, some fairly obvious. As
Americans first learned a century ago, the way to encourage
competition in an industry that tends toward natural monopoly is
through strong government regulation. That is the long-standing
purpose of antitrust laws. In this case, the FCC has the power to
force the cable and phone companies to open their lines--for a
reasonable price, of course--to the competing Internet providers
trying to enter the high-speed market. The problem of wiring the
last mile is a trickier one; but here, too, the government could
adopt measures like those it has traditionally used to encourage
new industries. Just as it helped develop the railroad, automobile,
and airline industries by subsidizing the construction of rail,
roads, and airports, the government could subsidize the last mile of
the information highway, either through tax breaks or outright
grants. (Former FCC chair Hundt and others have urged exactly
this.) By so doing, the government would also preserve its right to
demand open access to the broadband infrastructure it had helped
create.

But Powell, backed by the Baby Bells and the cable companies, has
rejected these forward-looking solutions in favor of a simplistic
mantra of "deregulation." "Deregulation is a critical ingredient to
facilitate competition," Powell announced when he was nominated
last year. But Powell's brand of deregulation protects the Baby
Bells and cable companies from competition in the illogical hope
that they will invest in new technology to improve transmission.
Far from increasing competition, it will reinforce the trend toward
monopoly.

At first, Powell's deregulatory crusade was largely rhetorical, but
this year he began to take action. In February, Powell, who enjoys
a three-to-one majority on the FCC, announced a "proposed
rulemaking" on "telephone-based broadband." According to the FCC's
decision, telephone-based broadband services are "information
services, with a telecommunications component, rather than
telecommunications services." The distinction sounds semantic, but
it has profound legal implications. According to the
Telecommunications Act of 1996, telecommunications services have to
grant open access to their facilities, but information services do
not. By defining telephone broadband as an information service--a
designation originally intended for content providers like
LexisNexis--the FCC removed it from regulation, allowing the Baby
Bells to ban other ISPs from transmitting over their lines.

The next month Powell struck again--getting his majority to declare
that cable-based broadband was "an interstate information service"
and not either a "telecommunication service" or a "cable service."
Here again, by defining cable broadband as an information rather
than a telecommunication service, Powell permitted cable to ban
other providers from using their lines. Moreover, by defining cable
as an "interstate" information service rather than a "cable
service," he removed it from any local regulation over prices and
service. Michael J. Copps, the sole dissenter on Powell's FCC, said
of the March decision, "Make no mistake--today's decision places
these services outside any viable and predictable regulatory
framework." Or as Governing magazine put it, the decision means
"local governments won't be able to enforce customer service
standards."

Lately, as deregulation has been discredited by scandal, Powell has
openly espoused the end to which deregulation was the means. In an
interview last month with The Wall Street Journal, Powell admitted
that he favored major (supposedly innovation-spurring)
consolidations in the telecommunications industry along the same
lines of those the defense industry underwent in the '90s. During
the '90s the defense industry was reduced from about a dozen to
three giant firms: Lockheed Martin, Raytheon, and Boeing. By that
logic, the telecommunications industry would consolidate into a
handful of firms based on the Baby Bells. But as Mark Cooper of the
Consumer Federation of America has noted, the two industries are
hardly analogous. Defense firms contract primarily with a single
buyer, the U.S. government, which enjoys substantial leverage over
them. They are thus intrinsically subject to government oversight.
Phone and cable monopolies, by contrast, contract with millions of
unorganized consumers who, in the absence of a vigilant FCC, can't
exert much influence over them.

If you want an analogy for what Powell is trying to do, you have to
look at the Bell system before the breakup of AT%amp%T in 1982 or
to the French telecommunication monopoly in the '90s. AT%amp%T was
broken up partly because its monopoly was stunting innovation and
removing competition. Long-distance prices fell 40 percent in the
decade after AT%amp%T's breakup. Similarly, French Telecom once
boasted about its Minitel network, which since 1981 provided
text-based, monochrome information services. But by the mid-'90s
its monopoly held back the introduction of the Internet, a far
better medium for conveying information. The U.S. telecom industry
could eventually suffer similar obsolescence under Powell's plans
for new consolidated regional monopolies.

Indeed, U.S. failure to wire the last mile is already undermining
its telecom industry in relation to competitors in South Korea and
Canada. South Koreans, for instance, are currently four times more
likely to have broadband than are Americans; and South Korean
telecom companies are now in a position to leapfrog their American
competitors in Internet technology in much the same way American
telecom firms leapfrogged the once-formidable Japanese during the
'90s. (This, too, was largely because the Japanese were held back
by a national monopoly, NTT.) Falling behind in telecom technology
won't just mean American consumers have to wait for affordable
broadband service. It will mean, as Powell himself argues, that the
telecom industry will likely remain in the doldrums--and perhaps
keep the overall economy there with it.

In June, when the Los Angeles Times asked Powell what he considered
his greatest accomplishment at the FCC, he responded, "I'm still
here." It was a joke that could just as easily have been made by
Paul O'Neill at Treasury, Harvey Pitt at the SEC, or Lawrence
Lindsey in the White House. Powell is yet another Bush
administration appointee who has not measured up to the daunting
challenge of a downturn that has swept away many of the gains
American industry made in the late '90s. Powell may indeed survive.
Sadly, the American telecom industry--and with it, hopes for a
near-term economic recovery--may not.

[Correction: We erroneously defined the acronym ISP as "independent
service provider." It has been corrected in this article.]

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