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Jewish World Review June 27, 2001 / 6 Tamuz, 5761

James K. Glassman

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Consumer Reports

Look to Politics to Find
Broadband's Market Cap Shortfall

http://www.jewishworldreview.com --
"ALL this year, victims of the 'tech wreck' have been looking furiously for someone to blame," wrote Ethan H. Hugo of David L. Babson & Co. in a recent letter to clients. Who's the scapegoat? Alan Greenspan? Greedy underwriters? Day traders? Instead of the usual suspects, Mr. Hugo offered as culprit "the slow adoption of residential high-speed 'broadband' Internet access. This is the business factor that has been causing so many shattered dreams."

He's right. The agonizingly slow deployment of broadband has stopped the Internet in its tracks. The technology for fast connections is well established, but 19 out of 20 U.S. families are stuck with poky dial-up modems, so it takes them an hour to download a video file that broadband could handle in two minutes.

By now, if broadband were widespread, Web companies would be offering online sports and movies, zippy online banking, video telephone calls, useful education services and health care. With widespread broadband, Americans would be buying faster, better computers, and telecom firms would be making huge investments in infrastructure. Instead, orders for capital equipment have fallen 13% since last year. Meanwhile, e-commerce firms that were counting on broadband are going out of business, the economy is suffering and, as Mr. Hugo says, high-tech stocks have suffered a train wreck.

Mr. Hugo, however, is wrong in one important particular. The broadband disaster is not strictly a business matter. Its causes and its remedy are, in fact, political. The problem is the bottleneck at the "last mile" -- the copper wires that lead into every American home. Today, 17 years after the court-ordered breakup of all-powerful AT&T, the local Bell monopolies -- once seven companies, now merged into four -- serve 95% of residences and small businesses.

Deregulating a monopoly built up through a century of government protection and subsidies isn't easy. If you do it all at once, the monopolist gets a windfall and blows away all potential competitors. So the Telecommunications Act of 1996 provided a more sensible blueprint. In a replay of the system that successfully deregulated long distance (driving prices down 40% since 1984), the bill required the Bells to unbundle their networks and resell their services at non-discriminatory wholesale rates to competitors. But the law lacked timetables and penalties. Instead, it offered an incentive: Open up your local loops, it told the Bells, and, state by state, you will be allowed into long distance. This seemed a decent deal for getting the benefits of lower prices, higher quality and broader dissemination to consumers.

The Telecom Act was the catalyst for a new industry, as 300 feisty competitive local exchange carriers (or CLECs), like Covad and Northpoint, were born. The Bells, which had kept a broadband technology called digital subscriber line, or DSL, on the shelf for 10 years, finally began to deploy it. But the Bells dragged their feet on allowing the CLECs into the local loop. The Bells were fined $370 million for their lack of cooperation last year -- a pittance compared to the tens of billions of dollars at stake. As Francis Rose wrote in Wired magazine: "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."

But the CLECs' misery wasn't over. Last year, two powerful congressmen, Reps. Billy Tauzin (R., La.) and John Dingell (D., Mich.), introduced a bill that would immediately welcome the Bells into the data part of long distance (the "good" part, which now represents 75% of all long-distance traffic, and rising) without opening their local networks. It would also bar the CLECs from connecting with more advanced parts of the Bells' loops.

Merely the existence of the contentious bill -- which passed Mr. Tauzin's Commerce Committee, got an unfavorable report from the Judiciary Committee and is now in the lap of the Rules Committee -- has eviscerated the CLECs. I recently completed a study with William Lehr, an MIT economist, that found that the progress of the Tauzin-Dingell bill is directly correlated with the obliteration of the market capitalization of the CLECs.

We constructed a broad CLEC index, which reached a peak market cap of $242 billion in March 2000. By last month, the market cap had dropped to $38 billion -- an 83% decline. Of course, the stock market as a whole, and high-tech stocks in particular, also fell over that period, but the tech-heavy Nasdaq (with the CLECs in our index removed) declined 48%. The drop in the CLEC index was greater by three-quarters than the Nasdaq loss.

In what economists call an "event study," Mr. Lehr and I looked closely at eight specific days when favorable news was reported on the progress of Tauzin-Dingell. During those days alone, the market cap of the CLEC index fell by $87 billion. In other words, 42% of the total decline in the CLECs' value occurred on positive Tauzin-Dingell days. 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, a sharp decline, probably between 40% and 80%, in capital investment by the CLECs in the near future -- that is, if any CLECs survive.

People of goodwill can differ on how to solve the broadband crisis, but the choice comes down to this: trust the monopolists or trust competition. The Tauzin-Dingell bill may squash the CLECs, goes the reasoning of its more candid advocates, but it will lead to more deployment of broadband -- and it gets the government out of the business of overseeing the interconnection process, so it's deregulation.

I disagree. Once the CLECs are wiped out, the Bells will extend their local monopoly into long distance and broadband, and Congress -- whether we like it or not -- will not stand by and allow them to set prices, quality and extent of service. What will the politicians do? Reregulate, of course. We'll be back in the pre-1984 era before we know it. Instead, the way to spread broadband is to enforce the Telecom Act of 1996 and unleash competition -- the messier and more chaotic, the better.


JWR contributor James K. Glassman is the host of Tech Central Station. Comment by clicking here.

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