In the mid-1990s as it seemed that lawmakerswere about to abandon much of the regulatoryapparatus that had hampered the telecommuni-cations industry since the 1930s, the telecomequipment industry began to boom, helped inpart by the rise of the Internet. The deregulatorytrend led ultimately to the 1996 Telecom Act, andsoon the architects and implementers of that actwere congratulating themselves on a job welldone. We were supposedly building a new tele-com infrastructure fit for the information age.

Then, in 2000, shipments of telecommunica-tions equipment went into sharp decline, andconstruction of the information age infrastruc-ture came to a grinding halt. Lots of money andjobs were lost, and the new class of telecom indus-try executives that had emerged in the post-dereg-ulatory era got most of the blame. These peoplewere thought to be manipulating the market andmisleading consumers about sales and growth.Once the truth came out—so goes the “official”story—the market collapsed.

However, even a fairly cursory glance at theactual history of this period suggests that the“official” story exaggerates the powers of seniortelecom executives and that a far better place tolook for a source of telecom’s collapse is the

Federal Communications Commission, which atthe time was determined to crowd as many firmsas possible into the telecom sector. That strategywas to be achieved by lowering barriers to entryand, in particular, by giving newcomers low-costaccess to the networks of the carriers. When itbecame obvious that the market was top heavywith competitors, the telecom bust occurred.

It would have been far better if deregulationhad simply let market forces do their work with-out scoring success primarily on the number ofcompetitors. If there was worry that the incum-bent carriers were so powerful that no meaningfulcompetition could emerge, policymakers shouldhave taken a look at newer technologies such aswireless and voice-over-IP, which are potentiallyhighly disruptive of the incumbent players’ posi-tion. The good news is that the kind of regulatorymeasures that brought about the telecom bustnow look like they are failing legal challenges. Butwhat happened to telecom in the late 1990sremains a cautionary tale of how reforming regu-lation rather than truly deregulating can lead todisaster. With Congress potentially poised to re-open and revise the Telecom Act, lawmakers mustlearn from the mistakes of the past and ensurethey do not repeat them.

Who Killed Telecom?Why the Official Story Is Wrong

by Lawrence Gasman

_____________________________________________________________________________________________________

Lawrence Gasman is president of Communications Industry Researchers, Inc., a telecommunications industry ana-lyst firm, and a senior fellow at the Cato Institute.

Executive Summary

No. 533 February 7, 2005

Introduction

When Bill Clinton signed the 1996Telecommunications Act into law, there wasa widespread consensus that it would sweepaway the dead hand of regulation and enablethe invisible hand of competition to build atelecommunications infrastructure fit forthe age of information. The only dissenterswere a few analysts—and even a lawmaker ortwo—with libertarian leanings who thoughtthe act did not go far enough—they wantedthe Federal Communications Commissionscrapped, for example—and a few on the leftwho felt that the act abandoned what theybelieved should be government’s role in pro-viding affordable and universal telephoneand data services.

Such voices of dissent became increasinglymuted as the years that followed saw a hugeboom in the telecommunications industry.As Figure 1 shows, shipments of communica-tions equipment from U.S. factories took offin an unprecedented manner during the1990s. In fact, the telecom boom began a fewyears before the 1996 act, presumably because

it had become apparent that there was a largemajority in Congress for “doing somethingabout telecom.” An omnibus deregulationbill became a virtual certainty and the marketacted accordingly.

With the act signed into law, politiciansand regulators were quick to congratulatethemselves on their success. Vice President AlGore, who may not have invented the Internetbut certainly made it his crusade during histime as a senator and vice president, said:

We are on the verge of a revolution thatis just as profound as the change in theeconomy that came with the IndustrialRevolution. Soon electronic networkswill allow people to transcend the bar-riers of time and distance and takeadvantage of global markets and busi-ness opportunities not even imagin-able today, opening up a new world ofeconomic possibility and progress.1

Reed Hundt—the FCC chairman whopresided over the implementation of the 1996U.S. Telecommunications Act2—had this to

2

The telecomboom began a few

years before the 1996 act, presumably

because it hadbecome apparent

that there was alarge majority in

Congress for“doing something

about telecom.”

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Figure 1

U.S. Communications Equipment Shipments

Source: U.S. Department of Commerce.

$ M

illi

ons

say about the impact of his time at the FCC:

The communications revolution hashad technological, economic and polit-ical dimensions that are each and allbeyond precedent or expectation. Themultifaceted revolution would nothave had such a grand scale and scopebut for the new laws that . . . wereenacted in the first term of theClinton-Gore Administration. . . . Nowseveral years after the events . . . itappears that by a combination ofdesign and luck, the Commission’seconomic and social decisions . . . havehelped foster the rise of not only theNew Economy, but the InternetSociety as well. These twin phenomenahave created more wealth and moreopportunity to enhance the quality oflife for all citizens than any nation hasever enjoyed.”3

Ironically, both these comments weremade just before the telecom industry wentinto steep decline in the year 2000. By thetime 2002 rolled around, Michael Powell,Hundt’s successor as chairman of the FCC,was summing up the realities of the telecommarketplace as follows:

This is an industry suffering—there havebeen nearly 500,000 jobs lost, a reported$2 trillion of market value extinguished,and by some estimates companies arelaboring under nearly $1 trillion in debt.Corporate governance scandals, over-capacity, hyper-competition in somemarkets, a retrenchment of capital, con-tinuing credit-rating downgrades, con-tinued cuts in work force and capitalexpenditures and bankruptcies sadlycharacterize the day. Few are prosper-ing. Few are growing. Few are spending.Few are investing. The status quo is cer-tain death.4

Telcos toppled. Equipment vendors evap-orated. Component companies collapsed.

And the image of the telecom industry CEOdiminished from that of Randian superheroto Dickensian villain. In a mid-2002 coverstory titled “The Great Telecoms Crash,” TheEconomist used a cartoon to illustrate theindustry’s woes. The cartoon showed a largecrater surrounded by a number of onlook-ers—presumably investors and employees oftelecom companies—prostrate before it. Thestory itself began by noting that, “the biggerthey are, the harder they fall.” And an editor-ial in the same issue conjectured that “therise and fall of telecoms may indeed qualifyas the largest bubble in history.”5

The Official Story

What was it that caused such a precipitousdecline? The telecom industry had alwaysbeen cyclical in terms of its capital expendi-ture, but cyclical is not the same thing as“boom and bust.” Likewise, one might haveexpected a tailing off of the huge investmentsthat began in the 1980s and that were intend-ed to turn the old analog voice network into adigital network that was equally capable ofcarrying voice, data, and video. But why wouldthat happen so suddenly?

The conventional wisdom—what we aregoing to call “the official story”—is that abunch of greedy carpetbaggers, perceivingthat there was something to all this Internetand “information age” stuff, jumped into thetelecom market, hyped it out of all propor-tion, and misled investors in order to booststock values. Then, at the last moment, as themarket began to acknowledge the hype andfraud, these crooks got out with their ownlarge personal fortunes mostly intact. Ac-cording to this explanation, the blame fortelecom’s collapse lies squarely in the laps ofgreedy businessmen and just shows whathappens when we try to deregulate. As exem-plars of that point of view, consider the fol-lowing quotes:

� “What has happened to the global tele-coms industry . . . is a salutary lesson to

3

The telecomindustry hadalways been cyclical in termsof its capitalexpenditure, butcyclical is not thesame thing as“boom andbust.”

all those who buy the simple proposi-tion that public is bad and private isgood.” (Will Hutton, “The Titanic Greedof the Telecom Giants,” Observer [UK],April 2001)

� “The broken business models and crip-pling debt are the wages of greed, corpo-rate crime and misguided regulation.”(Peter A. Bernstein, “What’s Wrong withTelecom,” IEEE Spectrum Online, January2003)

� “[WorldCom’s] financial troubles became asymbol not only of the collapse of the spec-ulative high-tech bubble in the 1990s, butalso of the greed and corporate malfea-sance that is synonymous with the time.”(Christopher Stern, “Judge Clears World-Com’s Exit from Bankruptcy,” WashingtonPost, November 1, 2003, p. A1)

Like all good half-truths, the official storyis indeed only half true. Of the big-nameexecutives in the telecom business in the bub-ble years, some were fools and a few werecrooks.6 There was not a John Galt amongthem. There were indeed less-than-perfectexecutives trying to convince anyone whowould listen—investors, the press, analystsand the general public—that the future oftelecom promised nothing but good things.But could it be that the telecom bust was setoff, not by the deregulatory zeal of the 1996act, but rather by the fact that it did not leanfar enough in the direction of deregulation?

Telecom ManagersBehaving Badly?

Let’s consider the inadequacies of the offi-cial story first. The biggest problem is explain-ing how the alleged bad guys got so muchpower. Many of the celebrity CEOs who areaccused of manipulating the industry duringthe bubble era were, after all, “newbies.”Consider the background of Bernie Ebbers,who was chief executive of WorldCom duringthis period. Before he started WorldCom,Ebbers ran hotels. Winnick, who was the co-

founder of Global Crossing, had a back-ground in junk bonds and, before that, in thefurniture industry. Similar biographies werecommon at the time. But it seems unlikelythat a handful of executives with those sorts ofbackgrounds could really have fooled so manypeople in an industry that is 130 years old witha mature and conservative management struc-ture and a sophisticated understanding ofwhat works and what doesn’t work—bothtechnologically and from a business perspec-tive. The telecom industry is not, and wasnever, the dot.com industry, run by youngmen and women who had little managementexperience, or even aptitude for management,and an insatiable appetite for hype.

The second big question is just how themen at the top could bend the industry totheir will. Almost no one believes that the tele-com bust was caused by senior managersdirectly stealing money from their firms.There were a few instances of such crimes, butnot enough to make the industry collapse.There were plenty of examples of poor man-agement and bad judgment.7 But again it’shard to make a strong causal link from that tothe devastating decline of the telecom indus-try. Then there were the “creative accounting”practices used to cover up losses by the bigtelecom companies as the telecom marketheaded south. The recognition that suchpractices were being used certainly did helplead to the crash. But they could just as easilybe interpreted as the actions of panicky man-agers as they could be interpreted as clevermanipulations by these same managers.Indeed, in the cases in which the supposed vil-lains were new to the industry, foolishnessand panic seem more plausible explanationsthan wickedness.

While in some cases, executives really didtry to mislead investors and the world atlarge about how well their own companieswere doing, one of the big myths about thetelecom go-go years was that those high up inthe industry were able to cover up the factthat the Internet was growing at a muchslower rate than was popularly supposed.The villain of the piece in this instance was

4

Could it be thatthe telecom bust

was set off, not bythe deregulatory

zeal of the 1996act, but rather by

the fact that it didnot lean far

enough in thedirection of

deregulation?

supposedly WorldCom, which, for historicalreasons, controlled much of the Internetbackbone and therefore had a better handleon how much traffic was actually flowingthrough the Net.

The specific claim that was usually madeat the time was that Internet traffic doublesevery 100 days. In his book Broadbandits, OmMalik ties what he calls this “urban legend”back to WorldCom in a number of ways,8 butthe kind of thing that was being said is wellillustrated by a quote from the late JohnSidgemore: “We’re seeing growth at anunprecedented level. Our backbone doublesevery 3.7 months, which means that it’sgrowing by a factor of 10 every year. So threeyears from now, we expect our network to be1,000 times the size it is today. . . . The bigchallenge is to deploy infrastructure fastenough to accommodate such a growth rate.We’re in a supply-constrained economy forthe first time in the telecom industry.”9 Withthat kind of comment from one of the mostrespected executives in the industry, it ishardly surprising that bankers, venture capi-talists, and stock investors felt comfortablepouring money into telecom.

Now, if the gripe is simply that WorldComexecutives sought to mislead the public aboutthe rate at which the Internet was growing,this may well be true. Broadbandits reports thatdespite frequent bullish pronouncementsabout the growth of the Internet, WorldCom’sactual traffic statistics were kept under “lockand key,”10 and it is indisputable that World-Com’s senior management were not the mosthonest people around, as later accountingfrauds were to prove.11 However, if the gripe isthat there was no contrary evidence fromrespectable sources and that investors, ana-lysts, and so on were forced to rely on the dubi-ous statements of WorldCom, this is simplynonsense. There were alternative sources oftraffic data from AT&T and others that pro-vided strong evidence that the Internet wasnot growing as strongly as the hype suggested.As early as October 1998, Andrew Odlyzko,then a research scientist for AT&T Labs, pub-lished a paper using data that showed that the

Internet was growing at between 70 percentand 150 percent per year.12

It was also possible to estimate futuregrowth of the Internet on the basis of plausi-ble consumer behavior. At the height of theboom, industry consultant Peter Sevcikexamined Internet growth based on all threeof the following data sets: (1) number ofusers—a relatively easy number to get hold of;(2) connect time; and (3) user profiles—Sevcik’s innovation. He came up with growthrates that were far more modest than any-thing that the industry—WorldCom or any-one else—would admit to at the time.13 Myown company published a couple of studiesin the same period examining the likelyfuture growth of the Internet infrastructurebased on the typical take-up of informationtechnology and consumer electronics prod-ucts. Interestingly, this showed Internetswitching, routing, and access equipmentexpenditures by North American carriersmore than doubling between 1998 and 2003and then falling off until the end of the fore-casting period, which was 2007.14

All in all, the official story as describedabove seems weak and makes a lot of leaps.That some of the highest officials in telecomgot out of the industry’s collapse with theirfortunes relatively intact is widely resented.For those who lost a lot of money—or theirjobs—in telecom in the past few years, suchresentment is understandable. But it doesn’tmean that the bigwigs of telecom were toblame for the crash. And even if they were—if itcould be proved that the telecom industry inthe 1990s was invaded by men and womenwith no moral compass whatsoever who ulti-mately wrecked the industry—this wouldimmediately just push the need for explana-tion one notch back. Why, one could ask, atexactly that point in time, and why in the tele-com industry? As for the data that showedthat business plans were being built on fairytale growth models for the Internet, this wasquite well known at the time. It was simplyignored. Om Malik in Broadbandits reports ofthe reception to Odlyzko’s paper that “Everytime Odlyzko put up an argument, it was like

5

There were alternativesources of trafficdata from AT&Tand others thatprovided strongevidence that theInternet was notgrowing asstrongly as thehype suggested.

screaming into a 100-mph gale force wind.”My own experience as a consultant was simi-lar. Identifying a client’s business plan asunrealistically bullish all too frequently pro-duced glazed eyes and the response that Icould not possibly be correct, since someother industry analyst had predicted thatwithin a year or two the market would beworth billions of dollars. The generalresponse to my company’s Internet forecastsfrom our clients was that they were far toopessimistic. This was hardly the case—sincethose 1998 projections didn’t even hint at thedebacle to come in telecom. So we were, inessence, wide-eyed optimists.

The Feds Did It!

It’s possible that the entire industry was ina state of denial or mass hysteria. But theremay be a less psychological explanation. Aswe have seen, there is little evidence that thepeople at the top of telecom had the power tocreate the telecom boom or the telecom bustall on their own. But there can be little doubtthat regulators and politicians do have suchpower. Much of the boosterism emanatingfrom the private sector could be dismissed asoverenthusiastic (and even perhaps unethi-cal) marketing. But the equivalent messagefrom the public sector was often far grander,as the earlier quotes from Gore and Hundtshow.

The pronouncements on the joys of tele-com by officials from the public sector—couched as they usually were in terms ofsocial revolution—must have done as much asanything to convince the public that a new erawas dawning and that this is where theirhearts, minds, and dollars ought to be. This iseven more likely to be the case, given that thepublic sector began its propaganda effort onbehalf of telecommunications much earlierthan the telecommunications industry itself.For example, as a senator, Al Gore cam-paigned for a government-funded informa-tion infrastructure and introduced legislationthat would extend the use of taxpayer-funded

research networks to kindergartens.15 Thebottom line is that politicians and regulatorswere setting the stakes very high and it wasthey, not private-sector managers, who hadthe power to restructure the telecom industryin a wholesale manner.

What is frequently assumed is that the1996 Telecommunications Act opened up thefloodgates to a wild horde of new telecomstart-ups that flooded the industry with goodsand services, so that eventually the bubblepopped. As the article in the IEEE’s Spectrummagazine quoted earlier puts it, “Too manycompanies chased too few customers and—tomake matters worse—many were using similartechnology.”16 What is interesting is that thiswriter believes that it is intuitively obvious thatsuch a situation could only be due to “greed.”He goes on to claim that another factor in thedownfall of telecom was “misguided regula-tion,” which he defines as “policies that pro-tected incumbent phone companies but weredisguised as competitive reform, like theTelecommunications Act of 1996 in theUnited States.”

My discussions in the industry stronglyindicate that these views are widely held. Butagain they are half-truths. Yes, the problemswere largely caused by “misguided regulation”and “too many companies chasing too manycustomers.” But the misguided regulation cer-tainly did not favor the incumbent phonecompanies—in fact, quite the opposite was thecase. And it was this misguided regulationitself—not greed—that led to the glut of tele-com products, services, and capacity. The realvillain of the telecom bubble in the UnitedStates was the 1996 TelecommunicationsAct—as interpreted by Reed Hundt’s FCC.

The Unbearable Lightness of Telecom Regulation

Perhaps it was just a slip of the pen, but thereference in the Spectrum article to misguidedregulation—rather than misguided deregula-tion—gets it precisely right. Although theword deregulation was repeated in mantra-

6

The real villain ofthe telecom

bubble in theUnited States was the 1996

Telecommuni-cations Act—as interpreted byReed Hundt’s

FCC.

like fashion by almost everyone in governmentand the industry when describing the 1996Telecom Act, the act was only deregulatory inthe sense that it swept away many of the oldregulatory structures that had evolved sincethe last omnibus telecom act, which was in1934. There was certainly a consensus amongboth regulators and legislators that the regu-latory environment for telecommunicationsin the United States was out of date.Unfortunately, looked at from some historicaldistance, that consensus also comprised adetermination that telecom should be gov-erned by new rules, not by no rules. While thederegulation of interstate trucking had at itscore the abolition of the regulatory agencygoverning trucking, there was never a seriousconsideration of shutting down the FCC.17

The 1996 act was regulation remade, not reg-ulation abandoned. Some of us noted that atthe time, although we still hoped for the best.In an article in Regulation magazine, publishedimmediately following President Clinton’ssigning of the 1996 act, I noted that the acthad been presented

as radical deregulation under which thecountry will move toward a brave newworld of telemedicine, distance learn-ing, and movies-on-demand. Accordingto the hype, such wonders will be creat-ed by the competitive forces that havebeen set free by the new act. But thetruth is that the TelecommunicationsAct of 1996 is a timid piece of legislationthat barely acknowledges the competi-tion that [is] emerging as the result ofnew communications technology. Andrather than diminishing the govern-ment’s role in directing the telecommu-nications industry, the bill has increasedit. . . . Of course the 1996 Act is not real-ly a piece of deregulatory legislation atall. By most accounts it adds more thaneighty new items to the FCC’s “to do”list.18

One conclusion that I might have drawnfrom this analysis is that more regulation was

likely to hurt rather than promote theprospects for telecom—after all, more regula-tion generally tends to be bad for business. Inretrospect, I wish I had made this point clear-er. However, I did note that the act left muchto the FCC and that it specifically enjoinedthe commission to

forbear from applying any regulationor any provision of this act . . . if thecommission determines that enforce-ment of such regulation or provision isnot necessary to ensure that charges,practices, classifications, or regulationsare just and reasonable [or] is not nec-essary for the protection of con-sumers.19

In this appallingly vague wording, Ithought might lie the salvation for telecomregulation. In the 1980s, under ChairmanMark Fowler, the FCC was highly restrainedwith regard to using its power. That helpedmake the 1980s a decade of growth for theelectronic communications business. Lessconspicuously, succeeding FCC Republicanchairmen took a similar approach, and Ithought that there was some hope that theClinton administration’s choice for FCCchairman, Reed Hundt, might adopt thesame strategy.

By 1996 it was already clear that theHundt FCC was playing fast and loose withthe First and Fifth Amendments to theConstitution in its approach to universal ser-vice and children’s television. “Universal ser-vice” originally referred to the Bell systempromise to provide nationwide service inreturn for its government franchise. In the1996 act it became a slogan for a broad rangeof redistributionist policies to bring subsi-dized services of all kinds to schools, ruralresidents, the old, the sick, and even thehomeless. These were goals heartily endorsedby the Hundt FCC.20 In the case of children’stelevision, the issue was writing new “publicinterest” rules for broadcasters—an issue dearto Chairman Hundt. In both cases, it becameclear quite quickly that property rights and

7

The 1996 act wasregulationremade, not regulation abandoned.

free speech were of far less concern thansocial goals as far as Hundt and his support-ers were concerned. Nonetheless, at the sametime the early Clinton-era FCC had alsoshown some inclination to forbear onadministrative matters. For example, Chair-man Hundt was on record as doubting thewisdom of government-mandated advancedtelevision standards. Furthermore, the “NewDemocrat” promise that they would makegovernment more efficient seemed to favorregulatory forbearance. After all, as I noteelsewhere, “Not applying rules costs noth-ing.”21

Loading the Dice

As it turns out, I was naive. Indeed, it issomething of an irony that a regulatoryframework created soon after the Reagan rev-olution ended up being in some ways moredirigiste than the 1934 act, which was createdat a time when the best minds all had a social-ist—or worse—bent.22 Although the 1996 actremoved some of the regulatory absurditiesthat had crept into telecom law since the1930s, it also essentially gave the FCC a man-date to define the rules and oversee the cre-ation of the new Internet infrastructure.

That might not have been so bad if theHundt FCC had not been so bent on carryingout its mission with such fervor. Moreover,whatever may have been the genuine inten-tions on the part of regulators to cut down onbureaucracy and regulatory baggage, theyseem to have failed in this too. A recent studyby Greg Sidak of the American EnterpriseInstitute indicates that the number of telecomlawyers, as measured by membership in theFederal Communications Bar Association,grew by 73 percent in the late 1990s. In thatperiod, there was also a 37 percent hike in FCCspending and a tripling of the number ofpages of regulations in the FCC Record in thepost–Telecom Act period.23

Worse still, the same false messianism thatdrove the Hundt FCC to impose its paternal-istic vision of kids’ TV and universal service on

America also drove it to foist a market-distort-ing vision of competition on the telecommu-nications industry. It was this more than any-thing that set the stage for the meteoric riseand precipitous fall of the telecom industry.More specifically, the Clinton administration,its FCC, and above all Chairman Hundt him-self had a vision of competition that seemed toemphasize quantity over quality. Thus inHundt’s book he congratulates himself on hissuccess interpreting and managing the 1996act: “Within three years [of the FCC’s efforts topromote ‘competition’] there were 6,000Internet service providers, 250 new competinglocal telephone companies, a half dozen newlong-distance companies, [and] dozens of newequipment vendors.”24

But as in so many matters—both privateand public—emphasizing quantity over quali-ty is not always wise and may be a sign ofnaivety. As I pointed out in another Regulationarticle in 1997: “The FCC assumes that morecompetitors means more competition andthat any competitor is as good as any other.But that egalitarian premise ignores the factthat a mix of large and small suppliers mightbe the best arrangement for providing ser-vices. . . . The FCC has again taken on the roleof centralized planner, almost guaranteeingan inefficient result. The consumer is the ulti-mate loser.”25 As it turned out, this was cor-rect, if not actually an understatement. It wasthe more-is-better philosophy of the HundtFCC that may have contributed more thananything else to creating the U.S. telecombubble that ultimately burst.

Here’s how it worked. Pervading all discus-sions of telecom regulation during the periodleading up to and soon after the 1996 act wassigned into law was the assumption that thesevered parts of AT&T were still too powerful,either as the result of their history as part ofthe Bell system monopoly or because theywere, in some sense, natural monopolies. Atsome level, this was hard to argue with. TheBaby Bells controlled the bulk of the physicalfacilities that provided local calls and accessto long-distance networks. In addition, theyhad a brand name, a technical skill set, and

8

Although the1996 act removed

some of the regulatory

absurdities thathad crept into

telecom law sincethe 1930s, it also

gave the FCC a mandate to

define the rulesand oversee thecreation of the

new Internetinfrastructure.

political savvy and contacts that no start-upcould hope to match.26

As a result, there was a consensus thatsomething needed to be done to give newcarriers a head start. Even some dyed-in-the-wool libertarians thought that, as a practicalmatter, this was necessary. We soothed ourconsciences by telling ourselves that someminimal force by the government was neces-sary to redress the government wrongs of thepast that established AT&T as a monopoly inthe first place,27 and which, in turn, resultedin an intolerable competitive environment.

The specific issue of concern here was thedegree to which the Bells should be forced togive newly emerging competitors access totheir networks. It was understood that if theBell companies simply refused to allow thenewcomers to send traffic over the incum-bent Bell networks, start-up local carrierswould have to incur huge upfront costs tobuild completely new networks from scratchbefore they had signed up any customers. Atbest, this would mean considerable delays inthe arrival of meaningful local telephonecompetition. At worst, investors would soonfind better ways to use their money than bet-ting on new entities whose competitiveadvantage over the Bells was far from clear.28

In the worst-case scenario, no competitionwould ever appear.

As an aside, it should be noted that thealmost universal assumption—that the Bellcompanies, if left to their own devices, wouldrefuse to cooperate with rivals in mutuallyprofitable situations—is wrong. Long-dis-tance companies regularly lease or trade facil-ities where this makes sense for both parties.So do Regional Bell Operating Companiesand the many independent (mostly rural)telephone companies that have always beenoutside the Bell system. This type of behaviorhas always taken place, even in the darkestdays of AT&T dominance. In addition,AT&T prior to its break up would sell its ser-vices through agents, where the local pres-ence of these agents in a small community orin an industry made that a commerciallyviable strategy for both sides. Indeed,

although under the leadership of TheodoreVail in the early days of the Bell system AT&Tdeliberately drove many small independenttelephone companies out of business byrefusing to connect them to the AT&T net-work, this turned out to be something of ashort-term solution. Ultimately, Vail had toturn to the government to protect the Bellsystems’ dominance.29

But to be fair, a willingness by incumbentlocal telcos to trade or lease facilities or useoutside agents in certain situations is not thesame thing as a willingness to open up net-works to competitors who exist primarily totake away much of the Bell’s business. Givenall of that, an insistence that the Bells openup their networks to competitors seems rea-sonable, although the Takings Clause in theFifth Amendment makes such action worri-some, even taking into account the mannerin which the Bell system acquired its power.30

Thus in 1994 the DC Circuit Court struckdown FCC collocation rules that gave com-petitors access to Bell central offices and useduncompromising language in its ruling, not-ing that the rules were a Fifth Amendmentviolation since a “permanent physical occu-pation authorized by the government is ataking without regard to the public interestthat it might serve.”31

It’s hard for a libertarian-minded analystnot to be sympathetic with this kind ofthinking. But sometimes property rights canbe a tricky issue, and, as a practical matter,few people have really questioned the notionthat some kind of forced facilities sharing is aprerequisite for broad-based competition toemerge in the local telephone market.However, it is also true that equally few peo-ple would question that such competitionwould ultimately have to be based on facili-ties owned by the Bells’ competitors, not onshared facilities. It is possible to imagineminimalist FCC rulings that would give com-petitors access to Bell facilities as a short-term break, with definite sunset provisions.32

This would (1) help the Bells’ competitors getover some barriers to entry, which probablywould not have emerged in a real free market

9

It should benoted that thealmost universalassumption—that the Bell companies, if leftto their owndevices, wouldrefuse to cooperate withrivals in mutuallyprofitable situations—iswrong.

in the first place, (2) force these competitorsto include building their own facilities intheir economic calculations from the outset,and (3) possibly get over one of the objectionsimplicit in the DC Circuit Court ruling men-tioned above—that the forced access wouldnot be a permanent one.

This minimalist approach is, however,inconsistent with the beliefs of Hundt andthe New Democrats that competition shouldbe defined mostly in terms of quantity ofcompetitors. If quantity is what you careabout most, then what you need to do isspecify forced access in such a way that youcan get as many people to rush into the mar-ket as possible and not make them worry allthat much about the future costs of buildinga network. Taking this approach is even moreattractive if you are, like Hundt, a man in ahurry, who wants to show that he can reformtelecom and then move on to some otherpowerful and lucrative position.

And it was all so easy to achieve. All Hundthad to do was come up with aggressive regula-tions that guaranteed cheap access to almostevery part of the Bell network. And hang theconsequences. Cato’s Adam Thierer pointsout that Hundt’s “managed competitionvision for the telecom sector could be filedunder the ‘burn the village in order to save it’theory of political philosophy.”33 Thierer goeson to note: “In several chapters of his book,Hundt boasts about Commission efforts todeliberately handicap the Bells and advantagerivals. Considerations of future innovationand investment took a backseat to the short-term goal of rapidly increasing the number ofnew entrants into the market.”34

Reed’s Big UnbundlingAdventure

The specific mechanism for implement-ing Hundt’s policies was something called,innocuously enough, “unbundling.” Thismeant that certain parts of the network wereidentified by the FCC as ones that had to bemade available to competitors at wholesale

prices. The methodology was not the FCC’schoice; it was mandated in the 1996 act, andit is difficult to see how even the most mini-malist forced access scheme could have pro-ceeded without something like unbundling.However, as with other requirements of the1996 act, much was left to the interpretationof the powers that be at the FCC. In particu-lar, the 1996 act said next to nothing abouthow the FCC should set prices for unbun-dled elements—it simply required that theybe based on “cost,” which left plenty of wig-gle room for Hundt and his associates.

With the regulatory forbearance traditionsof its predecessors in mind, the Hundt FCCcould have been quite conservative in its inter-pretation of unbundling. It could even havefound justification for a conservative ap-proach to unbundling in the 1996 act itself,since the act requires the FCC to considerwhether competition would be “impaired”before it defines an “unbundled network ele-ment.” But as the title of his book and itssomewhat manic tone indicate, Hundt sawhimself as a revolutionary, and “restraint”simply wasn’t in his vocabulary.

Recognizing that unbundling was the keyto bringing new businesses into the marketat a rapid pace, which was, as we have seen,Hundt’s definition of competition, theHundt FCC had the specifics of unbundlingready for use within four months of the pas-sage of the 1996 act. In the words of telecomscholar and lawyer Peter Huber, they

unbundled absolutely everything. The$25 electrician’s box on the outsidewall of most houses, where the phonecompany’s lines connect to the insidephone wiring. The loop that runs tothe central office. The switching equip-ment and software in that office. Thehigh-capacity fiber-optic lines thatconnect local offices to the long-dis-tance network, along with operatorand directory-assistance services. Andmore, much more.35

Moreover, “the new rules also required

10

Hundt saw himself as a

revolutionary,and “restraint”

simply wasn’t inhis vocabulary.

incumbents to offer all the unbundled ele-ments as a single re-bundled package—at thenew wholesale rate.”36

What this meant was that rather than giv-ing newcomers a little bit of assist to breakinto a market that the government had closedoff in the past, the FCC was making up forpast government sins by giving these new-comers the right to pillage the Bell networks.Hundt’s rush to action completely ignoredthe one thing upon which everyone seemed toagree—that the eventual goal of competitivepolicy in local telecommunications was tohave the “newbies” build their own networks.But as Huber pointed out, under Hundt’srules: “New entrants . . . would not have tobuild a single new item or a single new inch ofnetwork themselves if they did not care to.They could compete simply by placing a newlabel on the facilities that they had requisi-tioned, customer by customer, from the oldphone company.”37

Perhaps even more disastrous was the waythat “wholesale prices” were set for unbundledelements. After all, if all that the FCC had donewas to give competitors access to unbundledelements but had then set prices very high,nothing of significance would have ensued. Aswe have noted, the 1996 act required only thatthe FCC base wholesale prices on “cost.” A rea-sonable approach might have been to take theview that “cost” was what the Bells had paid.This would have also watered down the tak-ings argument, in that the Bell companiescould reasonably be thought of as having beenjustly compensated. Instead, futurists thatthey were, Hundt and his supporters at theFCC pushed for a cost definition based onwhat it would theoretically cost a competitor tobuild facilities on the basis of current technol-ogy, starting from scratch. This definition andthe process surrounding it is generally referredto as TELRIC, which stands for Total ElementLong-Run Incremental Cost. Because of therapidly falling price/performance ratios forany equipment based on microelectronics,this led to wholesale prices that were muchlower than might have been derived using his-torical costs.

Also, because the actual costs of equip-ment deployments are often significantlyhigher than the theoretical costs (because ofinefficiencies, such as equipment delays andbugs in the system), newcomers were boundto get a much better deal by using the Belllines than by building their own. Since thewholesale prices as calculated by the regula-tors could not take such problems complete-ly into account, the Bells not only had to givetheir rivals low-cost entry to the networks,they were also effectively forced to provide anelement of free service. All things considered,Hundt’s rush to make the market more“competitive” was virtually a giveaway for thenew entrants. Here is Huber again, describingthe bargains that were to be had in Hundt’severything-must-go sale:

A competing phone company can nowlease from Verizon, in perpetuity, anunbundled copper telephone line froman East 87th Street apartment to thebasement of 97th-and-Lexington forabout $15.50 a month. It can also lease,at regulated rates and for as long as itmay wish, a cage in Verizon’s basementto house any equipment it might careto connect to the line. Switching ser-vice will run the new company $5 amonth. Caller ID—which Verizon itselfwould sell to ordinary customers for$8 per month—will cost just twentycents at wholesale.38

And the competitive local exchange carri-ers—not to mention the folks who invested inthem—were very happy.

How Reed Hundt CreatedGreed

No wonder the market boomed. TheHundt FCC gave away the Bell companiesnetwork, and lots of new entrants jumped into seize the opportunity. As new local serviceproviders appeared in droves, so did newlong-haul investment and both new equip-

11

Hundt’s rush to make the market more“competitive”was virtually agiveaway for thenew entrants.

ment companies and components compa-nies designed to support the new local andlong-distance networks that were being built.It was widely believed—correctly to someextent—that new carriers would prefer to dealwith equipment suppliers with which theyshared an entrepreneurial spirit and that thenew carriers might not get the same atten-tion that the Bells got from establishedequipment firms such as Nortel or Lucent. Inaddition, there was a prevalent view that thenew carriers would need different kinds ofequipment than the old carriers. For exam-ple, it was said that the new guys on the blockwould have to focus on leading-edge servicesto best compete with the Bells and that theywould have to widely deploy wave divisionmultiplexing systems to cost optimize thefiber they acquired from the Bells.39

However, it is unlikely that much seriouseconomic analysis was ever done to supportsuch propositions or, indeed, much of theother conventional wisdom of the day.Hundt’s FCC could hardly have come upwith a better scheme to attract the recklessand put off entrepreneurs with an eye tobuilding real businesses. First, the federal reg-ulators not only brought down the barriersto entry in the local telephone business; theyended up subsidizing market entry. Thenregulators, politicians, and industry leaderswent around the country making speechesabout how fast the market was going to growand how much money there was to be made.So greedy fools rushed in where economical-ly rational angels feared to tread. Althoughboth liberal and conservative journalistsspent a lot of time whining about the greedyfolks who killed telecom, let us all rememberthat it was Gore and Hundt who wanted peo-ple to rush into the business in order to cre-ate a competitive market, which they haddefined purely as a numbers game.

What the Hundt unbundling schemeactually created was a boondoggle. Foolscould go into business using the Bell net-works at bargain basement costs. Theythought that there were big bucks to be madeshort term, because telecom was the latest

fad and the Internet was “where it’s at.” Theycould forget about ever having to build theirown networks. Their competitors would pro-vide them. By contrast, the sober entrepre-neurs realized that there was never going tobe enough money in the business to justifytheir own networks, primarily because theywould, from the get-go, be competing againstnumerous new entrants who were subsidizedby the unbundling scheme.

Meanwhile, the unbundling scheme wasmaking things hard for the Bells on a num-ber of levels. A government scheme thatessentially confiscates large chunks of a pub-lic company’s strategic assets is not a policydesigned to keep its share price high. As theunbundling scheme took effect, Bell shareprices fell, forcing the companies to take onmore debt and making them think twiceabout investing in their network at all. It wasnot just a matter of capital expenditures in ageneral sense. When Bell companies came upwith an innovative new service, they wereoften compelled to help their rivals get intoprecisely the same service. For example, as Ipointed out in a 2001 paper for Cato, it was

a regulatory nightmare for a Bell com-pany to provide wavelength services.Immediately after the 1996 act wassigned into law, some state public utili-ty commissions ruled that if a Bellinstalled any wave division multiplexing[WDM] equipment . . . they would beforced to sell some of the channels totheir competitors. The result was pre-dictable. In 1997, U. S. West stoppeddeployment of WDM systems, eventhough WDM was much less expensivethan laying additional fiber. . . .Eventually, the FCC overruled thosedecisions. Currently, as long as a Bellcan prove that it is deploying WDMchannels merely for its own commercialuse, it will not be forced to give its com-petitors access to them. But this is onlya modest improvement, because if a Bellcompany sells just one channel to acompetitor for good commercial rea-

12

Gore and Hundtwanted people to

rush into thebusiness in order

to create a competitive

market, whichthey had defined

purely as a numbers game.

sons, it opens itself up to the charge thatit has installed WDM for reasons otherthan its own use, and it is likely to beforced to make all of its wavelengthsavailable to its competitors.40

So unbundling, as defined by the FCC,caused new carriers to jump into the telecommarket without a care in the world and littleregard to building physical networks in thefuture. At the same time, the unbundling dis-couraged more conservative entrepreneurswho wanted to get into the business with thelong term in mind by slowly building up theirown infrastructure. Finally, it even discour-aged the Bells from investing in the future.

And gradually the Hundt plan unraveled.While Chairman Hundt himself could leaveoffice claiming victory for his policies, it soonbecame obvious that his vision was ill-consid-ered at best. For in his desperate haste toensure that anyone with a taste for telecomcould get into the business, little thought wasgiven to how these new entrants could actual-ly make money without networks. And essen-tially there was only one way—piece togetherunbundled elements of the Bell networks ininnovative ways and re-brand them with yourown name. It is possible to imagine someonemaking a long-term business out of this bycatering to some niche user market. The valueadded—the margins—in such a businesswould be derived from the new entrants’knowledge of the specialist market, not fromnetwork costs. But to expect a business to sim-ply use the Bell networks, re-brand them, andthen cater to a broad-based audience is expect-ing a lot, especially given the strength of theBell brand in the first place. Maybe a new car-rier or two could get lucky on this model, butit isn’t very likely. Probably, the best that couldbe hoped for is that some new entrants couldtap into the price sensitivity of the telephonebusiness, attract some customers away fromthe Bells, bleed cash for a while, and then selltheir customer base back to the Bell they tookit from in the first place.

For all these reasons, the kind of competi-tion (if that’s what it was) that had been pro-

moted by Hundt’s scheme was virtually cer-tain to come unglued. And it did. The new“value chain” that had been created by radicalunbundling turned out to be a house of cards.It wasn’t just the new telcos themselves thatfailed. Almost every equipment company thatcame into being during the telecom boom hasnow disappeared, having been acquired orsimply gone out of business.41

Why did the market collapse when it did—in the year 2000? There may have been no sin-gle reason. Perhaps federal telecommunica-tions policies had lowered barriers to a pointthat the numbers of competitors in all seg-ments of the telecom market had reachedsome kind of “tipping point,” at whichimplosion became inevitable. Recent work inchaos theory has made it a widely acceptedfact that fairly small events in an economycan have catastrophic outcomes if the condi-tions are sufficiently unstable. Could it allhave gone another way? Or was the inventionof the World Wide Web and the irrationalexuberance that flowed from it destined toproduce a gold rush mentality? The ultimateanswers to these questions will come fromfuture technology historians writing at atime when tempers have had a chance to cooland damaged careers and investment portfo-lios have repaired themselves.

But writing from the perspective of 2004,it is hard not to conclude that the FCC couldhave done a much better job. Surely there wassome way to avoid the thousands of pages ofnew regulations and, indeed, making aneffort to avoid such bureaucratic encum-brances is exactly what one might expectfrom government-efficiency-loving NewDemocrats. Unfortunately, what we shouldalso have expected is exactly what we got— anattempt to manage a complex socioeconom-ic environment so that everyone gets “fair”access to the network,42 with big businessesseen as the enemy to be punished in someway. If this all just sounds like thinking fromthe 1960s, remember that Reed Hundt tookthe name of his book from the title of aBeatles’ song and that Democrats of a differ-ent generation have been highly critical of

13

Unbundling, asdefined by theFCC, caused newcarriers to jumpinto the telecommarket without acare in the worldand little regardto building physical net-works in thefuture.

Hundt’s way of doing things. Thus AlfredKahn, who chaired the Civil AeronauticsBoard as it was being dismantled, has calledHundt’s pricing rules TELRIC-BS. “BS,”Kahn claims, stands for “blank slate.” But weall know what he really means. Although notof a different generation, Eli Noam, professorof economics and finance at ColumbiaBusiness School (and once talked about as apossible future Democratic commissioner onthe FCC), has written of TELRIC that “cost isoften calculated on the basis of impenetrableengineering models that Lenin would haveliked if he only had had computers.”43

While the Hundt unbundling rulesallowed him to claim early success andadvance himself personally, I doubt there wasever a cynical and deliberate conspiracy topush the personal interests of Hundt, Gore,and their cronies any more than there was aconspiracy to push those of the leaders ofWorldCom, Global Crossing, et al. It is muchmore likely that they simply got caught up inthe limitations of their own worldviews. Inthe case of Reed Hundt, his background inantitrust law meant that it was impossible forhim to conceive of competition in more real-istic terms.

A more economically literate and less ide-ological FCC chairman might have lobbiedsimply for removing the regulatory barriersto entry in the telephone business and givingprospective entrants a bit of help for a while,by making sure that the Bells couldn’t kill offcompetition before it got started. But ifHundt and his friends in the administrationand at the FCC had taken that route, theywould have also had to accept an end game inwhich the Bells competed for the major seg-ments of the local telephone business44 witha small number of other large powerful enti-ties. This is pretty much the structure thatfree markets dictate for highly capital inten-sive industries. But this type of oligopolisticsituation would be anathema to a ClintonianNew Democrat with a built-in mistrust oflarge establishment businesses and a roman-tic idea of what competition actually lookslike in the real world. For it seems that, in

their resentment of big business, NewDemocrats differ from those to their left onlyin the sense that New Democrats suffer fromthe fatal conceit that competition in privateindustries, such as the telecom industry, canbe easily managed to meet certain socialgoals, while Leftists want direct governmentcontrol—that is, a whole new system. ReedHundt’s FCC was a textbook case of NewDemocrat thinking.

Now that the damage has been done, howcan it be corrected? The future is beginning tolook a little brighter, for both regulatory andtechnological reasons. On the regulatoryfront, the recent FCC Triennial Review onunbundling went some way toward address-ing some of the problems of unbundling inthe area of new services. Meanwhile, courtchallenges to the facilities-sharing rules haveproved successful. In March, 2004, the U.S.Court of Appeals for the District of Columbiasaid that the unbundling rules could not bejustified, and three months later the SupremeCourt refused to intervene.

The danger hasn’t passed, however. TheTriennial Review left much undone, whileadding to the bureaucracy and boostinglawyers’ fees rather than increasing consumerbenefits.45 And the FCC is now attempting torewrite the rules to make them more palat-able to the courts. In addition, both theunbundling rules and the universal servicerules that stem from the 1996 act as inter-preted by Hundt’s FCC are becoming institu-tionalized. The latest generation of regula-tors and communications lawyers by nowprobably finds it hard to imagine that thereare other ways of doing things. Careersincreasingly depend on keeping things theway the FCC made them following the 1996act, and any attempt to reverse the rulescould be delayed for years by litigation andfights among the FCC commissioners.

In addition, there are calls for more regu-lation by those who never much liked theidea of deregulation in the first place.Writing in the American Prospect on what hecalls “The Great Telecom Implosion,” PaulStarr claimed:

14

The future isbeginning to look

a little brighter,for both

regulatory andtechnological

reasons.

A century ago . . . the Progressives weredivided in their response to the rise ofbig business. Some sought to restorethe earlier entrepreneurial world . . .others accepted the large corporationand called for regulation to achieve lib-eral ends. By the New Deal, the secondviewpoint had decisively won out.Despite the romantic appeal of compe-tition and the imperfections of regula-tion that hard won realism will have towin out again.46

This is a dreadful prospect for America,but there remain two big hopes for telecomreform in the long run. First, that the currentdominant regulatory ideology—that man-aged competition is the only way to go in thetelecom industry—will give way to a morelaissez-faire approach. As problems with the1996 act grow, there will surely emerge a newgeneration of Young Turks who want toaddress these problems with free-marketsolutions. The subtitle of a book by PeterHuber sums up what is needed: Abolish theFCC and Let Common Law Rule the Telecosm.47

The other big hope for telecom is thattechnological change will make current regu-latory structures obsolete as telecom marketsbecome more contestable. While the burstingof the telecom bubble has led to a lack ofinvestment in new telecom technology, thebad memories will ultimately pass, and tele-com will return to its historical pattern ofbeing a rather conservative industry thatnonetheless makes regular technologicalleaps forward. There are a couple of bighopes for disruptive technology here. One iswireless, which has two potential impacts ontraditional telecommunications. First, con-sumers—especially younger consumers—areshifting to cell phones as their primarymeans of telephone communications. This isbeginning to take a significant bite out of thewireline revenues of the incumbent carriers.The reason for this trend is that mobile tele-phony typically comes with many more fea-tures than the regular telephone service. Andit also usually offers free long distance.

Unlike a few years ago, the quality differencebetween wireline and wireless communica-tions is now relatively minimal.

The other hope from wireless is that fixedwireless can offer an alternative to copper andfiber-optic cables in access networks. This hasbeen talked about for almost two decades, anduntil recently one didn’t see that much fixedwireless in the access infrastructure except insome of the newly emergent nations, where itsdeployment was mainly motivated by howquickly a network could be installed, ratherthan its cost relative to wireline communica-tion. (It is obviously quicker to install a net-work of wireless transponders than to rewirean urban area with fiber.) However, the successof “WiFi” networks for mobile computing inthe home, office, and public buildings hasgiven a new impetus to fixed wireless.Although WiFi is probably not going to pro-vide a ubiquitous public access platform, it ispart of the solution. Similar technologies—notably “WiMax”—may well enable fixed wire-less to emerge as a major part of the access seg-ment of the public network over the comingdecade.

WiFi and WiMax are industry standardsthat came out of the Institute of Electricaland Electronic Engineers’ 802 Project, whichis primarily focused on standardizing localdata networks. As such, voice is not the pri-mary concern of these standards. However,over the past decade it has become increas-ingly practical to convert traffic into packet-ized data traffic—more specifically, InternetProtocol traffic—and transport it in exactlythe same way that other IP data are carried.As a result, in the context of WiFi, it is nowpossible to imagine a home in which boththe computers and the phones are connectedto the home WiFi network and both the datatraffic and the voice traffic are sent andreceived over the Internet.

There’s a lot more to Voice-over-IP(VoIP)48 than just running data over homeWiFi networks. At a physical level VoIP trafficcan be carried over both wireless and wirelinenetworks, and it appears to promise radicallyimproved economics for voice traffic. And,

15

Technologicalchange will make current regulatory structures obsolete as telecom marketsbecome morecontestable.

like the shift in mobile communications, it isa serious threat to the incumbent voice carri-ers who have built their networks on anentirely different technology—time divisionmultiplexing (TDM)—and consequently onentirely different business models. The rise ofboth wireless and VoIP therefore presentschallenges to the Bells and other incum-bents—carriers that, at the time of the 1996act, were universally seen as possessing hugetechnology and established network advan-tages over any newcomers.

This is not the place to go into detailabout either the technology or the economicsof wireless or VoIP. However, it is worth not-ing that they present practical short-termways for potential rivals to the Bell compa-nies to get into the business with physicalnetworks that are separate from the Bell net-works—and there is a widespread consensusthat it will only be when this happens thattrue competition will have arrived. WhenCongress was putting together the 1996 act,it was not seriously considered that VoIP andwireless could prove significant challenges toBell dominance of the market. At the time,there seemed no serious alternatives to forcedaccess to the Bell networks being provided tothe new entrants. The only debate was overthe extent and length of time that this wouldbe provided.

Now it looks like new technology couldultimately supply a genuine alternativeaccess to telecom policy based on forcedaccess and that there is even more reason totruly deregulate telecom—that is, to abandonregulation rather than merely reform it.Technological change may eventually meanthat many of the most cherished assump-tions of the 1996 act will follow those of the1934 act into the dustbin of telecom history.One can only hope that, this time, it won’ttake more than 60 years for it to happen. Inany case, no matter how telecom deregula-tion evolves in the early 21st century, whathappened to telecom in the late 1990sremains a cautionary tale of how reformingregulation rather than truly deregulating canlead to disaster.

Notes1. Quoted in Victor Rivero, “Electronically Shapinga New World Order,” Government Technology, August1999, http://www.govtech.net/publications/eCommerce/aug99/newworld.phtml.

2. Our concern in this paper is primarily with theUnited States, but we note that (1) the debacle inthe U.S. telecommunications industry, whichaccounts for some 40 percent of the world mar-ket, was a major contributory factor in the world-wide crash of the industry and (2) much of thepoorly designed regulation that led to the crash inthe United States was mirrored by the behavior ofregulators in Europe and elsewhere.

3. Reed E. Hundt, You Say You Want a Revolution: AStory of Information Age Politics (New Haven, CT: YaleUniversity Press, 2000), pp. ix–x.

4. Michael K. Powell, speech at the Goldman SachsCommunicopia XI Conference, New York, October2, 2002, http://hraunfoss.fcc.gov/edocs_public/attachmatch/DOC-226929A1.pdf. The conferenceseems very badly named under the circumstances.

5. The Economist, July 20, 2002, pp. 9, 59–61.“Telecoms” is the British contraction of “telecom-munications.”

6. By far the best researched and entertaining sin-gle source of biographical information on bubble-era telecom executives is Om Malik’s bookBroadbandits: Inside the $750 Billion Telecom Heist(Hoboken, NJ: Wiley, 2003). I have drawn on thatbook throughout this paper, even though—as thispaper makes clear—I don’t quite share the viewthat the telecom debacle was a “heist.”

7. For example, according to Malik (pp. vii–viii),Ken Rice, the former CEO of Enron BroadbandServices, “was more interested in his collection ofFerraris and motorcycles than in running EnronBroadband.”

8. See Malik, pp. 13–16.

9. Daniel P. Dern, “Intranet Visionaries, Part II: AnInterview with John Sidgemore,” Telecommuni-cations, August 1997. Sidgemore came to World-Com via WorldCom’s acquisition of UUNet, amajor Internet provider and was considered one ofthe most important people in the industry duringthe glory days of the telecom boom. Ultimately,Sidgemore ran WorldCom for a short while afterthe fall of Bernie Ebbers. He died during the periodthat this paper was being written and, as his obitu-aries pointed out, he was one of the few highlyplaced telecom executives to get through the tele-

16

No matter how telecomderegulation

evolves in theearly 21st century,what happened to

telecom in thelate 1990s

remains a cau-tionary tale of

how reformingregulation rather

than truly deregulating canlead to disaster.

com bubble with his reputation unscathed.

10. See Malik, p. 13.

11. For the story of the fall of WorldCom, seeLynne W. Jeter, Disconnected: Deceit and Betrayal atWorldCom (Hoboken, NJ: Wiley, 2003).

12. Andrew Odlyzko and Kerry Coffman, “TheSize and Growth of the Internet,” First Monday,1998, http://firstmonday.org/issues/issue3_10/coffman/index.html.

13. Peter Sevcik, “The Myth of Internet Growth,”Business Communications Review, January 1999.

14. “Internet Implications 2: What Building theInternet Will Mean for Service Providers and TheirSuppliers,” Communications Industry Researchers,1998.

15. See Lawrence Gasman, Telecompetition: The FreeMarket Road to the Information Highway (Washing-ton: Cato Institute, 1994), p. 107.

16. Peter A. Bernstein, “What’s Wrong withTelecom,” IEEE Spectrum Online, January 2003, http://www.spectrum.ieee.org/WEBONLY/publicfeature/jan03/comm.html.

17. Except by a small group of analysts and com-mentators from libertarian and conservativethink tanks and—for a short while anyway—by theSpeaker of the House, Newt Gingrich.

18. Lawrence Gasman, “The TelecommunicationsAct of 1996,” Regulation no. 3, 1996.

19. 1996 Telecommunications Act, Section 160(a)(1).

20. See Lawrence Gasman, “Universal Service: TheNew Telecommunications Entitlements and Taxes,”Cato Institute Policy Analysis no. 310, June 25, 1998.

21. Gasman, “The Telecommunications Act of 1996.”

22. This is most obvious in the reform of the“Universal Service” requirements, which were for-mally embodied in law for the first time in the1996 act. See my “Universal Service: The NewTelecommunications Entitlements and Taxes.”

23. See J. Gregory Sidak, “The WorldCom Fraudand the Collapse of American Telecommuni-cations after Deregulation,” Yale Journal onRegulation 20 (2003): 207.

24. Hundt, pp. 193–94.

25. To be fair, nobody involved with the telecomdramas of the mid to late 1990s was that interest-ed in pinning down what they meant by competi-

tion—although they all knew it was a good thing!This is quite understandable, since public fig-ures—whether politicians, legislators, or regula-tors—are prone to bland statements. Anythingmore precise might have serious political costs.This is a pity, since without a clear definition ofcompetition in telecom it is impossible to deter-mine whether the expected goals of competitionare likely to be achieved.

26. There was always some competition for the Bellcompanies and even for the pre–break-up AT&T,since, where appropriate, large organizations couldbuild their own private networks, which mightinclude their own physical facilities. Since the1980s, alternative carriers had emerged to providenetworking facilities for this special application,and AT&T actually competed for this type of busi-ness with its former “daughters” once their divesti-ture had occurred. However, everybody agreed thatthe purpose of reforming existing regulation wasto ensure that residential consumers, small busi-nesses, and smaller organizations more generallywould have a wider choice of communicationsoptions. As we have already noted, nobody speci-fied how wide.

27. The history of the Bell system from the 1934Communications Act onward was dominated bythe understanding that government would pro-vide AT&T with guaranteed profits and keep outall competition in return for it providing nation-wide service—one of the key goals of the 1934 act.The Bell System also had to stay out of certainbusinesses and make its intellectual property uni-versally available. That seemed to work wellenough before the technological revolution inmicroelectronics led to today’s rich landscape ofactual and potential telecommunications ser-vices. In any case, although it seems that todayalmost any successful firm attracts accusations ofmonopoly—the latest and strangest examplebeing Google—nobody could argue with suchaccusations against the old AT&T. AT&T in theold days was the classic monopoly—a private gov-ernment concession from which all others wereexcluded at the risk of legal action.

28. In the 1980s long-distance competitionemerged quite rapidly and successfully. However,its economics were quite different from localcompetition. In the old Bell system, AT&T LongLines priced high in order to subsidize AT&T’slocal telephone systems—this was part of its uni-versal service deal with government at the time.However, even after the break-up of the Bell sys-tem, AT&T was typically the most expensiveoption, so it was relatively easy for even low-qual-ity alternatives to compete with AT&T on price.Although successful alternatives to the Bell sys-tem emerged in the 1980s for specialized business

17

services, any newcomer attempting to competewith the Bell local services more generally facedan uphill battle to survive in a policy environmentwhere state and federal regulators insisted—evenafter the Bell break-up—that local phone chargesshould be as low as possible.

29. For a discussion of voluntary interconnectionin the electronic communications business, see thesection on “Competition and Interconnection” inGasman, Telecompetition, pp. 120–22.

30. For an excellent discussion of forced accessand “takings,” see Adam Thierer and ClydeWayne Crews, What’s Yours Is Mine: Open Access andthe Rise of Infrastructure Socialism (Washington:Cato Institute, 2003), pp. 9–12.

31. Bell Atlantic Corp v. FCC 24 F.3d, 1441, DCCircuit, 1994.

32. Adam Thierer has suggested February 8, 2006,as a cut-off date. This would be the 10th anniver-sary of the 1996 Telecommunications Act. By thistime, he believes it would be possible for newphysical (wireless and fiber) facilities to be builtthat could compete with Bell networks. See AdamThierer, “UNE-P and the Future of Telecom‘Competition,’” Cato Institute TechKnowledge no.48, February 1, 2003, http://www.cato.org/tech/tk/030201-tk.html.

33. Ibid.

34. Ibid.

35. Peter Huber, “Telecom Undone,” January,2003, http://www.manhattan-institute.org/html/_comm-telecom.htm.

36. Ibid. This piece gives an excellent, if depress-ing, account of the many bad things that havegrown out of the Hundt FCC’s unbundling doc-trine, including burgeoning bureaucracy and liti-gation.

37. Ibid.

38. Ibid.

39. Wave division multiplexing enables multiplestreams of information to be sent down a singlefiber.

40. Lawrence Gasman, “Why ‘Fair’ CompetitionFails in the Telephone Industry: The Case ofWavelength Services,” Cato Institute TechKnowledgeno. 27, November 26, 2001, http://www.cato.org/tech/tk/011126-tk.html.

41. For example, “Wave Division Multiplexing,

Photonic Switching and the Coming of AllOptical Networks,” Communications IndustryResearchers, 1999, listed 45 companies active inthe business of selling equipment for optical net-works. Of these, 14 are still selling such equip-ment. And only 3 of these were created during theoptical telecom, the rest being the giants of thetelecom and CATV industries such as Lucent,General Instrument, and so forth, which haveevolved since the beginning of that industry.

42. This is even more obvious when universal ser-vice issues are brought into the picture.

43. Eli Noam, “Regulating in Order to Deregulate,”FT.com, May 2002.

44. The crux of the 1996 act was opening up com-petition for the mass-marketed communicationsservices bought by residential users and smallbusiness, not bringing more companies into themarket for specialist business services. In manyways these had been competitive for some time.

45. My primary concern in this paper is to analyzethe underlying causes of the telecom bubble.Although the unbundling issue lies at the heart ofthis “mystery,” explaining the likely consequencesof the latest version of unbundling contained inthe 576-page, 2,447-footnote Triennial Reviewlies beyond the scope of this present piece. For anexcellent analysis of the review, see Adam Thierer,“Was the UNE Triennial Review Worth the Wait?Part 1: The Process,” Cato Institute TechKnowledgeno. 57, http://www.cato.org/tech/tk/030829-tk.html; and Adam Thierer, “Was the UNE TriennialReview Worth the Wait? Part 2: The Substance,”Cato Institute TechKnowledge no. 58, http://www.cato.org/tech/tk/030915-tk.html.

46. Paul Starr, “The Great Telecom Implosion,” theAmerican Prospect, September 9, 2002, pp. 20–24.

47. Peter Huber, Law and Disorder in Cyberspace:Abolish the FCC and Let Common Law Rule the Telecosm(New York: Oxford University Press, 1997). Itshould be noted that, for Huber, antitrust law is ade facto part of common law. This would not bethe view of all libertarian-leaning analysts, andsome of us would like to see antitrust law play littleor no role in future telecom policy.

48. The reader should note that there is a distinc-tion between “voice-over-IP” and “voice- over-the-Internet.” The former describes the use of a par-ticular networking protocol (i.e., IP) to carry voicetraffic. It leaves open what kind of network isgoing to be used for transmission. For example,VoIP can be and is used instead of standard PBXsin some offices. Voice-over-the-Internet meansprecisely what it says. Thus, all voice-over-the-

18

Internet is VoIP, but not vice versa. This is animportant distinction because the technologicalproblems that emerged as VoIP was developedhave largely been solved, whereas sending voice-over-the-Internet still presents network engineer-ing challenges because of the complex nature ofthe Internet itself. Thus we are not quite at a pointwhere voice-over-the-Internet is a complete alter-

native to regular voice service in terms of quality.It should be remembered that in the early days oflong-distance deregulation, much the same couldbe said about the services that were alternatives toAT&T. This changed quite quickly as these ser-vices reached critical mass and quality became akey competitive issue. We will see much the sameevolution pattern with voice-over-the-Internet.

19

SELECTED TELECOMMUNICATIONS STUDIES FROM THE CATO INSTITUTE

Is America Exporting Misguided Telecommunications Policy? The U.S.-JapanTelecom Trade Negotiations and Beyond by Motohiro Tsuchiya and AdamThierer, Briefing Paper no. 79 (January 7, 2003)

A 10-Point Agenda for Comprehensive Telecom Reform by Adam D. Thierer,Briefing Paper no. 63 (May 8, 2001)

ADDITIONAL STUDIES ON TECHNOLOGY AND TELECOMMUNICATIONS

Understanding Privacy—And the Real Threats to It by Jim Harper, Policy Analysisno. 520 (August 4, 2004)

Compulsory Licensing vs. the Three “Golden Oldies”: Property Rights,Contracts, and Markets by Robert P. Merges, Policy Analysis no. 508 (January 15,2004)

“Net Neutrality”: Digital Discrimination or Regulatory Gamesmanship inCyberspace? by Adam D. Thierer, Policy Analysis no. 507 (January 12, 2004)

The Internet Tax Solution: Tax Competition, Not Tax Collusion by Adam D.Thierer and Veronique de Rugy, Policy Analysis no. 494 (October 23, 2003)

Why Subsidize the Soapbox? The McCain Free Airtime Proposal and the Futureof Broadcasting by John Samples and Adam D. Thierer, Policy Analysis no. 480(August 6, 2003)

Birth of the Digital New Deal: An Inventory of High-Tech Pork-BarrelSpending by Adam D. Thierer, Clyde Wayne Crews Jr., and Thomas Pearson, PolicyAnalysis no. 457 (October 28, 2002)

Human Bar Code: Monitoring Biometric Technologies in a Free Society byClyde Wayne Crews Jr., Policy Analysis no. 452 (September 17, 2002)

Online Travel Services: The Antitrust Assault on Orbitz—And on Consumers byJames V. DeLong, Policy Analysis no. 441 (June 4, 2002)

Policing Pirates in the Networked Age by Stan Liebowitz, Policy Analysis no. 438(May 15, 2002)

Caught in the Seamless Web: Does the Internet's Global Reach Justify LessFreedom of Speech? by Robert Corn-Revere, Briefing Paper no. 71 (July 24, 2002)

Internet Privacy and Self-Regulation: Lessons from the Porn Wars by Tom W.Bell, Briefing Paper no. 65 (August 9, 2001)

Will the Net Turn Car Dealers into Dinosaurs? State Limits on Auto SalesOnline by Solveig Singleton, Briefing Paper no. 58 (July 25, 2000)