ROBERT E. LITAN
I will start with a confession: I am a telecommunications neophyte, having only recently learned how to use the Internet. But I know from my job and from casual reading that the United States--and indeed the world--is in the midst of a telecommunications revolution that will have profound consequences for every aspect of our lives.
At the global level, telecommunications helped end the Cold War. The former communist countries could not control the flow of information that personal computers and television delivered about life in the West. Ultimately, political freedom itself spilled over from West to East.
Within the United States, telecommunications products and services are powering economic growth. According to the Council of Economic Advisers, firms engaged in the information-services sector of our economy--including computers, software, telecommunications services, and equipment--accounted for 9 percent of the nation's Gross Domestic Product in 1993. Assuming the administration's telecommunications reform proposals are enacted by the next Congress, this share could double over the following decade.
Meanwhile, advances in telecommunications have been transforming our daily lives. It is difficult to remember life without fax machines or e-mail, both of which have dramatically speeded up communications on the job. Some people may already feel the same about videoconferencing, which may be standard practice in relatively few companies now but surely will be common throughout the country in just a few short years.
In our homes, the telecommunications revolution has already dramatically lowered long-distance telephone rates, while bringing dozens of video channels to our television sets. Millions of Americans are now also using online information services and the Internet to communicate with each other, with a growing number of libraries and other databases, and with people around the world.
The future promises even more video interactivity. Once they are fully built, fiber optic highways and satellites will do for video what copper wire did for voice: allow individuals to interact with one another rather than passively receive information or entertainment.
These are not simply pie-in-the-sky predictions. By the time the Federal Communications Commission (FCC) completes its auction, investors are likely to have plunked down billions of dollars for spectrum rights that will enable providers to deliver these services to the public.
The question this paper addresses is: What public-policy issues are raised by the spread of computer- and video-based interactivity? There are many, and I certainly do not feel competent to address them all. Instead, I would like to concentrate on two very simple but powerfully important objectives that government policy makers should focus on as the telecommunications revolution proceeds.
First, policies should be in place to assure that firms in all parts of the telecommunications industry--those building the infrastructure and those developing the content that will travel over it--have the maximum incentive to innovate and to develop and deliver products and services of the highest quality at the lowest cost.
Second, the telecommunications services that are generated should be made available broadly, not just to the fortunate few. Information networks have positive externalities: the more people hooked up to the networks, the more valuable the hookups are for each participant.
Moreover, information is what economists call a public good. We educate our children, at public expense, by giving them the information and skills they will need to lead productive lives, because it is in everyone's interest for all kids to grow up to be responsible adults. Similarly, we provide libraries, also at public expense, so that knowledge is made freely available to all segments of society.
Now that technology is revolutionizing the way information is delivered--over wires, over the air, and through computers--it is vitally important that all citizens continue to have at least some access to the information services of the modern age. This does not mean that everyone should be entitled to order movies on demand in their homes at subsidized rates. However, it does mean that great attention will have to be paid to ensuring that all of us have some basic level of access to the services and information that will be delivered over the information highways of tomorrow. By making sure that competition governs the telecommunications marketplace, the federal government can both provide incentives for innovation and encourage widespread availability of new telecommunications services.
This is an objective shared by all government agencies responsible for telecommunications policy: the FCC, the Department of Commerce, and the Antitrust Division of the Department of Justice. The rest of this paper will explain why competition is so important and how, in concrete terms, the Antitrust Division in particular has promoted and will continue to promote innovation in the telecommunications industry by protecting the competitive process.
The notion that competition is critical to the development of telecommunications services has not been, and may still not be, accepted by everyone. For decades following the invention of the telephone, for example, it was widely assumed that telephone service was a natural monopoly. Public policy makers embraced this assumption by allowing AT&T to run the nation's telephone network free from competitive challenge.
More recently, some parties have suggested that the need for standards in computer-based systems is incompatible with competition. For example, Bill Gates has asserted that Microsoft's operating systems for personal computers have become industry standards and thus have characteristics of a natural monopoly. While each of these arguments in support of natural monopoly may be appealing superficially, neither, on closer examination, justifies the rejection of the central role of competition that they both imply.
Consider first the claim of natural monopoly in the telephone business. This notion was roundly rejected when the Department of Justice and Judge Harold Greene forced the breakup of AT&T in the early 1980s. The breakup was not a universally popular move, even inside the Reagan administration. In fact, according to published accounts, President Reagan, Secretary of Commerce Malcolm Baldrige, and Secretary of Defense Casper Weinberger believed that the AT&T monopoly was a national treasure that should not be broken up. But William Baxter, then the assistant attorney general for antitrust at the Justice Department and now professor emeritus at Stanford Law School, insisted that only by divesting the regional telephone monopolies from AT&T's long-distance monopoly would long-distance competitors to AT&T have a fair chance to hook up to local telephone networks.
Professor Baxter and Judge Greene were right. Look what has happened since the breakup:
It is possible, if not likely, that within a few years the coaxial cable owned by cable television operators will be delivering local telephone traffic, just as it is doing today for nearly 400,000 customers in the United Kingdom. In addition, a variety of wireless technologies--including cellular, specialized mobile radio, and the new personal communications services portions of the spectrum--could create powerful competition to land-line telephone services.
Of course, cable and other alternatives to the RBOCs' local telephone monopolies will arrive only if state and local regulators permit them to compete. So far, only a few states have taken steps to remove restrictions to entry into the telephone business. Later, this paper will address the need for other states to eliminate these artificial and unnecessary barriers to entry.
What about the claim that the need for standards leaves little room for competition? This argument is flat wrong. It may well be true that once a standard has been accepted in the marketplace, such as the QWERTY layout on a typewriter, competition is no longer possible. But, with the one qualification I will discuss shortly, competition should actually govern the development of the standards themselves.
Microsoft proves this point. Microsoft gained a monopoly in operating systems for personal computers in the 1980s by successfully marketing DOS and Windows, which became industry standards. There was nothing unlawful about this. But then the company adopted certain licensing practices--"per processor" licenses that taxed competing operating systems and set lengthy terms and large minimum commitments. This effectively froze competing operating systems out of the original equipment market, the largest channel for distributing this type of software. The Justice Department sued Microsoft because these practices, coupled with restrictive nondisclosure agreements imposed on developers of applications software, unlawfully entrenched the company's monopoly and thereby deprived competitors of a fair shot at becoming the next standard. Microsoft has signed a consent decree, which the District Court for the District of Columbia disapproved in February 1995 but which I fully expect the Court of Appeals to approve on appeal. When it does, this decree will help level the playing field in the PC operating systems market.
The Microsoft case teaches an important lesson. It is perfectly legitimate to own a technology or product that becomes a standard, but it is against the law to erect barricades to competing, would-be standards. This proposition is especially important in high-technology industries, where rapid innovation may create frequent opportunities for new standards to replace old ones. If the owners of the old standards are allowed to use any means to block entry of the new, then innovation itself will be discouraged and consumers will lose out.
The one qualification to the proposition that competition should govern the development of standards is that in some cases, it may be in society's interest for competitors to agree on standards, or, in effect, to work jointly to create standards. For example, manufacturers may lawfully cooperate to set quality standards, saving regulators the time and expense of certification. A number of bodies in the telecommunications and computer fields perform similar functions.
But even in these cases, the joint-venture partners in the standards process must not abuse their legitimate collaboration to distort the competitive process. Thus, standards-setting bodies should be open to all parties who meet reasonable criteria for membership. In addition, the standards-setting process must be a fair one and not serve simply as a device for preventing new competitors or new standards from entering the market.
In sum, competition must remain the central governing principle for the information age. Competition encourages continued innovation and guarantees consumers the lowest prices for telecommunications and information services, and by so doing it promotes the widespread availability of these services.
If there is any doubt about these propositions, one need only look to Europe and Japan. Both regions have continued to follow the state-directed, monopoly model in telecommunications, and they now find themselves playing catch-up to the United States. For instance, it was recently reported that Japan's telephone monopoly, NTT, is far behind the U.S. regional telephone companies in laying fiber optic cable (Hamilton, 1994). In addition, European governments have been taken to task for sheltering their telecommunications giants from both domestic and foreign competition (The Economist, 1994). This criticism is not hard to understand. One recent study projects that an end to telephone monopolies in Europe would not only lower prices but improve quality by 40 percent (Hudson, 1994).
The benefits of competition are being recognized closer to home. In September, Canadian regulators took a major step to promote competition by allowing telephone companies to transmit video images and by opening up local telephone markets to competition from cable television operators and other sources. If the United States wants to continue to lead the world in telecommunications innovation, it must act soon to move in a direction similar to Canada's; that is, it must clear away the remaining obstacles to fair and effective competition throughout the telecommunications industry.
Along with the Federal Trade Commission (FTC), the Justice Department's Antitrust Division is charged by federal law with protecting and promoting competition. Next, this paper will consider how the division has been fulfilling this mandate in ways that affect the future of telecommunications.
One of the defining characteristics of the current revolution in the telecommunications field is the dizzying pace of corporate mergers. It seems that not a week goes by without one or two major mergers or corporate alliances being announced, each advertised as an ideal way to accelerate the building of the information superhighway by combining the unique talents and expertise of the two partners.
In many cases, this may be true, and the division will not stand in the way of these arrangements. However, we draw the line, as the law requires us to, at mergers that threaten to concentrate economic power in particular markets or to erect barriers to the entry of competitors.
Mergers involving telecommunications and computer firms can pose special problems for those who enforce antitrust laws, because many of the firms in these industries already have dominant, or even monopoly, positions. The seven RBOCs, for example, each currently has a monopoly in local telephone service. The same is true for almost all cable television firms in the markets they serve. Other high-technology firms also have substantial market power in various lines of business.
Firms that are already dominant in their markets surely know that neither the division nor the FTC is likely to permit them to engage in horizontal acquisitions, that is, purchases of direct competitors. As a result, many of the high-technology mergers we have seen so far involve the marriages of firms dominant in one market with firms in related markets--such as RBOCs proposing mergers with cable companies, telephone companies active in different geographic areas proposing mergers, and so on. The critical question posed by these mergers is whether they will allow one or both of the firms with dominance in one market to extend market power to a second market--a special danger where the acquiring firm is a regulated monopoly. If so, antitrust enforcers try to persuade the parties to revise their plans in ways that remove the anticompetitive effects of the transaction. If this fails, we will sue to halt the merger.
Two recent examples demonstrate how it is possible to prune the anticompetitive effects from otherwise lawful telecommunications mergers. The first is the union between AT&T and McCaw Cellular Communication, both dominant players in their respective markets. As noted earlier, AT&T still has about 60 percent of the long-distance telephone market. Overall, McCaw carries about 30 percent of the nation's cellular traffic, but in some regions of the country this figure is closer to 50 percent. In seeking to acquire McCaw, AT&T clearly wanted to provide seamless local and long-distance cellular service to customers.
Without any conditions, however, this proposed merger posed risks to competition in several markets. Under the original proposal, the parties wanted to be able to market to their customers a combined long-distance/local-service cellular package, without giving them a choice of another long-distance carrier. Given McCaw's market power in various localities and AT&T's market power in long-distance, this proposal could have significantly distorted competition in the long-distance market by diverting customers away from other long-distance companies based on factors other than quality or price, further entrenching AT&T's already dominant position in long distance.
To address this problem, the division conditioned its approval of the merger on McCaw's providing to competing long-distance carriers equal access to its subscribers. This is what the RBOCs now are required to do for long-distance traffic on their land lines, and the Department of Justice has proposed that they do the same if they are allowed to provide long-distance service to cellular customers. In addition, the consent decree that the parties signed prohibits AT&T from offering its local and long-distance cellular services as a bundle; the company must instead separately price each service.
The AT&T/McCaw merger also posed a threat to competition in local cellular markets. AT&T currently is the dominant manufacturer of equipment for cellular carriers, including many of the RBOCs that compete with McCaw. Given the nature of cellular systems, once a carrier begins purchasing a particular brand of equipment, it gets locked in to that brand for some period of time. The additional danger posed by the merger was that AT&T could exploit its position in the cellular-equipment market by raising prices or denying or delaying the delivery of parts and other services to RBOCs that compete with McCaw in local cellular service. Knowing this, rival cellular carriers and AT&T/McCaw could implicitly decide to keep cellular prices high. The consent decree prevents this result by prohibiting AT&T from such conduct. In addition, it addresses the lock-in problem by allowing, under certain circumstances, cellular equipment customers of AT&T to sell back their equipment to AT&T, if they want to, at cost minus a reasonable allowance for depreciation.
The second telecommunications merger approved subject to important conditions is the purchase by British Telecommunications (BT) of a 20 percent interest in MCI, as well as the creation of a global joint venture between the two companies. This transaction raised important telecommunications issues in an international context. Like AT&T and McCaw, MCI wanted its equity partnership with BT in order to enhance its ability to offer seamless telecommunications services, in this case on a worldwide basis. If BT did not have market power in telecommunications services in the United Kingdom, it is unlikely that either the proposed equity investment by BT in MCI or the joint venture would pose any competitive risks.
But BT was and remains the dominant telephone company in the United Kingdom. By virtue of this dominance, BT would gain from the proposed transaction both the incentives and the ability to favor its joint venture with MCI in pricing, interconnection, and possibly other ways--all to the detriment of U.S. users of other global telecommunications providers. If this occurred, then the prices on telephone traffic between our two countries would increase.
Accordingly, the division imposed several conditions on the BT/MCI transaction. Most important, the parties agreed to publish detailed information about the terms and conditions of services that BT provides to the joint venture and to MCI. This information will give ammunition to any disfavored competitors that wish to lodge complaints with regulatory authorities in either the United States or the United Kingdom. Such a "transparency" provision is less intrusive and less costly, but no less effective, than direct regulation.
In addition, the consent decree prohibits BT from providing to either the joint venture or to MCI confidential information about other international telecommunications providers. Moreover, the parties agreed that if a significant act of discrimination in favor of the joint venture or MCI occurs in the future, the department may seek modification of the decree to strengthen its nondiscrimination provisions.
What about future mergers in the telecommunications industry? It is difficult to be specific, because some are pending now before the division. It is possible, however, to offer several broad comments on the relation between competition policy and mergers in the industry.
There has been much talk about "the" information superhighway. In fact, several highways appear to be in the works--land-line telephone, land-line cable, and various wireless technologies--all competing to deliver voice and video content to businesses and homes around the country. No one really knows which of these highways will be successful. That is what markets are for--to let the firms that are now spending billions of dollars to build these highways fight it out.
For those charged with enforcing the antitrust laws, three concerns are paramount.
First, we do not want any highway owner that now has a regulated monopoly in its market to cross-subsidize. That is, cable operators who want to enter telephone markets, or local telephone companies that may eventually gain entry into long-distance markets, should fund their expansion only from the capital markets and not from their customers. The same is true for regulated telephone companies hoping to offer video and other services. To allow any other result is to permit the marketplace to favor monopolists, to the detriment of consumers.
Second, at least for the next several years, we should not allow the owner of any one highway in a given geographic area to merge with or buy out a competing highway. If, for example, local telephone companies were permitted to merge with their cable television competitors in the same service territory, neither firm would retain the incentive to develop and supply the new interactive services that consumers have been promised. This situation may change once technology affords consumers more ways to receive information in the home. In the meantime, however, it is prudent to prohibit for a reasonable period marriages of cable and telephone firms operating in the same service areas; the administration has suggested 5 years.
Third, we will be especially watchful of mergers or joint ventures between owners of highways and owners of content. Such transactions may create strong incentives for the integrated entity to deny competing programmers access to the highways. In such cases, we will be prepared either to block the merger or to condition it on "equal access" requirements that prevent such discrimination, as we did with TCI's acquisition of Liberty Media.
It is one thing to prevent mergers that threaten to choke off competition. It is another to ensure that such competition is allowed to take place. Current law, however, largely presumes that certain telecommunications markets should be monopolies and therefore insulated from competition. Therefore, unless the Supreme Court holds that federal law is unconstitutional (as have three federal courts), local telephone companies will remain barred from offering video services in their service territories. As noted earlier, local telephone companies are legally insulated from competition in all but a few states. In addition, the consent decree governing the AT&T breakup prohibits the RBOCs from competing in long-distance telephone services.
In 1994, Congress came very close to enacting comprehensive legislation that would have paved the way for erasing each of these barriers to competition. The Clinton administration worked closely with Congress to achieve passage of this legislation and intends to continue that partnership in 1995. In the meantime, the administration urges the states to remove barriers preventing new entrants in the local telephone business. New York, Wisconsin, Illinois, and a number of other states have already taken such steps or will soon do so.
Competition is vital if America is to maintain its leadership in telecommunications technologies and services. Competition also will best advance the goal of universal service, since competition will encourage providers to lower their own costs, and thus their prices to consumers.
Still, even a vibrantly competitive telecommunications marketplace will not deliver its services to all consumers. Some will lack the income to buy. Others services may be too costly for private suppliers profitably to provide. The most efficient and least distorting way to fill these gaps is to provide subsidies to those who would otherwise not be able to purchase competitively priced telecommunications services. The legislation considered by Congress last year would have directed the appropriate federal and state regulatory bodies to move in this direction.
The message here has been a simple one. Monopolies in telecommunications are dead or dying. This is good news, for only through vigorous competition will the telecommunications revolution we are now witnessing bring its full benefits to American consumers. The Justice Department's Antitrust Division is working hard to make this happen. We hope that Congress will assist us in this task by enacting soon the comprehensive telecommunications legislation that is so sorely needed.
Hamilton, D.P. Wall Street Journal. August 15, 1994. Getting wired: big fiber-optic project is private sector's job, Japan reformers say. A1.
Hudson, R.L. Wall Street Journal. September 30, 1994. World business (A special report): An industrial revolution. R20.
The Economist. August 13, 1994. Europe's dash for the future. 13.
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