Letter from AEI Resident Scholar Tom Hazlett to House Judiciary Committee Chairman James Sensenbrenner (R-WI). Re: Testimony of AEI Resident Fellow James Glassman to the House Judiciary Committee re HR 1542, the Tauzin Dingell bill. Date: June 12, 2001. Source: BellSouth provided Tech Law Journal with an MS Word version of this letter.

June 12, 2001

Hon. F. James Sensenbrenner
Chair, House Judiciary Committee
U.S. House of Representatives
Washington, D.C. 20515

cc: Members of the House Judiciary Committee

Dear Chairman Sensenbrenner:

Having read the testimony of my friend and AEI colleague, James Glassman, given before your committee on June 5, 2001, I feel compelled to respond. As a long-time fan of Glassman’s writings on politics and economics, I am – well, let’s just say it: I plan to call for an internal AEI investigation to find the real Jim Glassman. As an economist who has specialized in the analysis of telecommunications markets for over 15 years,[1] I believe my sharp disagreement with the entire argument put forth by the person claiming to be Jim Glassman should be registered.

The Bandwith Race, the Regulatory War. Today, the residential broadband access business is not so much a market, as it is a race to create a market. The primary contestants are cable companies, offering high-speed Internet access via cable modems, and telephone companies, providing digital subscriber line (DSL) service. As recently as 1999, the smart money – in part fueled by a public prediction from Cisco CEO John Chambers -- was betting on DSL to emerge the clear victor.

Yet cable is blowing out the competition. As of December 31, 2000, residential cable modem subscribers outnumbered DSL customers 4.7 million to 1.7 million.[2] This market test has clear implications: Cable’s unregulated position has allowed it to sprint ahead in the bandwidth race, attracting capital more easily and installing customers more rapidly.

This is ironic to advocates of regulation, who predicted that cable’s "closed" platform would stymie network development. Just the opposite has occurred. The over-regulation of telephone company networks, including advanced technologies not yet in place, has discouraged investment. It has done this partly by appropriating (or threatening to appropriate) investments made to offer new services. And it has done so by splintering responsibility among service providers, confusing consumers, and blocking efficiencies associated with vertical integration.

Even while cable systems have benefited from lower "regulatory overhead," the threat of access regulation has produced a visible reduction in investment incentives there, as well. Cable operators under-allocate spectrum to high-speed access, preferring to save channel space for low-rated cable channels rather than enhancing Internet access functionality. Fear of common carrier regulation is the reason. Likewise, in a study forthcoming in the STANFORD TECHNOLOGY LAW REVIEW,[3] George Bittlingmayer and I show that advances in "open access" rules result in negative returns for Internet infrastructure shares. This is market evidence that investors do not believe that access regulation will result in better networks for customers.

What Glassman writes about unbundling regulation is exactly right: "How did forcing a company to give away its property at prices set by government become an issue of ‘openness.’? If we try to allocate slots on the broadband infrastructure based on somebody’s notion of ‘the public interest,’ we’ll wander into a regulatory swamp from which we will never return. And consumers will suffer."[4]

The only glitch is Glassman’s application. He is apparently unaware that "open access" mandates are enforced not on cable operators, but on telephone companies. And the disincentives that he cites are already hammering broadband network development by discouraging investment in both industries.

Broadband race contestants are painfully aware of this fundamental reality. Both cablecos and telcos have succumbed to the temptation to promote costly regulation for their rivals. They have advocated "level playing field" approaches that perversely ratchet up regulatory controls to constrain competitors. This punishes consumers – with diminished service and higher prices – in attempts to divert market share from rivals.

The sunshine peaking through this dark Washington sky is that key players are talking cease-fire. Verizon CEO Ivan Seidenberg, writing in the Wall Street Journal on March 1, 2001,[5] promoted the idea that "open access" mandates on both cable and telephone network builders should be dropped. This armistice has gained favor with major cable television companies (with the notable exception of AT&T[6]), as the National Cable Television Association has declared itself neutral on the deregulation of phone facilities in the Tauzin-Dingell legislation while stressing its belief that cable modem access should likewise be left unregulated.

This thaw produces an opportunity for pro-consumer reforms by stripping away the threat of regulatory appropriation that Glassman rightly (if one-sidedly) condemns as an impediment to investment. This is the promise of the Tauzin-Dingell legislation.

*

An unpublished, yet to be released study. Mr. Glassman based his remarks on an ongoing study that has yet to be released. I look forward to seeing this work, and suggest that inferences be held until such time as the analysis is publicly available and subject to the standard give-and-take in policy debate and academic discourse. (Jim and I are arranging such a discussion, to be held at AEI, in the near future. You will be more than welcome to attend.) In response to his "preliminary" representations, however, the following points should be made.

• Glassman states: "[A] key contributor to the slowdown in the U.S. economy is the slowdown in the dissemination of broadband."

I am happy to agree, having written of "The Broadband Recession." (So have many others.) There are a number of factors that inhibit deployment of broadband technologies, including regulations that kill incentives to create advanced communications infrastructure and parsimonious spectrum allocation for wireless. The effective solution is to deregulate across the board, freeing rival technologies to serve consumers quickly and efficiently.

• Glassman states: "[O]ur research found that an index of CLECs fell more than 80 percent [between March 1, 2000 and April 30, 2001]. Remarkably, we discovered that almost half of that decline was concentrated in the handful of days when the market learned that this bill [Tauzin-Dingell] or its predecessor was more likely to pass. A rich academic literature shows that capital investment for companies and sectors is tied to the direction and extent of market capitalization. We can expect, then, to see a sharp decline – probably in the 80-percent range – in capital investment by CLECs in the near future. This decline has already begun... It can only be reversed by wiping out the possibility of passage of a bill such as HR 1542."

In fact, there is a "rich academic literature" noting the relationship between equity values and investment, as well as the effect of public policy on share prices. I have written a small part of that literature.[7] I believe that Mr. Glassman’s conclusion is wholly unwarranted from the facts now in evidence in financial markets.

Competitive local exchange carrier (CLEC) share prices have lost value in the tech stock swoon of 2000-2001. During the period analyzed by Glassman, the NASDAQ index dropped 55%. CLEC stocks, if more volatile than the NASDAQ as a whole, would naturally (if painfully) decline by a larger percentage. The CLEC sector has been hit, and hit hard, by negative investor sentiment that has swept B2C, B2B, wireless, telecommunications infrastructure, optical networks, and other information technology shares in recent months. But to attribute this to pending legislation appears an entirely unwarranted leap of faith.

Indeed, Cisco share prices declined 74% during the period Glassman cites. This is notable on two counts. First, it shows the general trend in the sector was not limited to CLECs. Second, Glassman – as a financial expert – has been recommending Cisco as a good buy to investors for many months.[8] If Cisco was caught in a downdraft created by the specter of Tauzin-Dingell (Glassman’s apparent claim for the CLECs), Glassman failed to inform his readers of this high-risk event when touting shares of the leading Internet infrastructure stock. An oversight? Or is Tauzin-Dingell a phantom risk?

*

Sincerely,
 

Thomas W. Hazlett, Ph.D.

Footnotes

[2] Precursor Watch: Residential Broadband Deployment Outlook (February 22, 2001).

[3] Thomas W. Hazlett and George Bittlingmayer, The Political Economy of Cable ‘Open Access,’ STANFORD TECHNOLOGY LAW REVIEW (forthcoming, Spring 2001).

[4] www.techcentralstation.com/WhereWeStand.asp (visited June 10, 2001).

[5] Ivan Seidenberg, Stop Blocking the Broadband Revolution, WALL STREET JOURNAL (March 1, 2001).

[6] C. Michael Armstrong, CEO of AT&T, responded to Seidenberg in an article entitled, Break Up the Baby Bells!, WALL STREET JOURNAL (March 28, 2001).

[7] See George Bittlingmayer and Thomas W. Hazlett, DOS Kapital: Has Antitrust Action Against Microsoft Created Value in the Computer Industry? 55 JOURNAL OF FINANCIAL ECONOMICS (March 2000), 329-359).

[8] James Glassman, Technology's Tough 2000 Holds Valuable Lessons, FOLIOFN.COM (January 30, 2001). Cisco is currently listed in the Glassman Tech Top Thirty: “We love Cisco. We love their sales machine, we love their uncanny ability to acquire and integrate new technologies into their product line, and we love that CEO John Chambers is a strong opponent of new online sales taxes.” Available online (as of June 11, 2001) at: http://www.techcentralstation.com/Glassman.asp?FormMode=Lookup&ID=4 .