The New Republic

MICHAEL POWELL V. THE ECONOMY Cable Access by John B. Judis

Post date: 08.27.02 Issue date: 09.02.02

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 independent 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&T in 1982 or to the French
telecommunication monopoly in the '90s. AT&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&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.

John B. Judis is a senior editor at TNR.

Copyright 2002, The New Republic


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