- The Washington Times - Sunday, February 4, 2001

The Bush administration deserves great credit for quickly recognizing and reacting to the nascent economic downturn. Its commitments to reducing taxes and restoring balance to our energy policies are commendable and correct.

With the appointment of Michael Powell to chair the Federal Communications Commission, it now appears the administration is prepared to take on another cause of the current economic problems: Overregulation of the information technology sector.

The problems in the IT sector are the direct result of a failed attempt by the FCC to manufacture competition in the market for local telephone service. By forcing incumbent providers to lease out their facilities below actual costs, the FCC hoped to "jump start" competition by a new generation of telephone resellers known as "competitive local exchange carriers" or CLECs.

These new companies would lease telephone lines from the incumbents (ILECs) and resell them to customers. Someday, the commission hoped, they would also invest in new facilities.

To achieve this goal, the commission put in place one of the most arcane and complex regulatory schemes ever devised. This approach significantly reduced the incentives of both incumbents and entrants to invest in new facilities.

As Justice Stephen Breyer said in a key 1999 Supreme Court decision, such rules "may diminish the original owner's incentive to keep up or to improve the property by depriving the owner of the fruits of value-creating investment, research, or labor… . Nor can one guarantee that firms will undertake the investment necessary to produce complex technological innovations, knowing that any competitive advantage deriving from those innovations will be dissipated by the sharing requirement."

In short, why would anyone build new facilities when you can lease existing facilities for less? To make matters worse, the commission has now allowed this complex regime to spill over into the market for broad band. Thus, rules originally intended to inject competition into the traditionally monopolized market for plain old telephone service have ended up being imposed on the new, inherently competitive market for data i.e., on the Internet.

To compound the problem still further, the FCC dragged its feet in reforming the antiquated system of cross subsidies and price controls commonly known as "universal service" rules. As a result, phone companies are still required to service residential customers at rates far below costs. In New Jersey, for example, the incumbent phone company is required to sell residential telephone service for $8.25 per month. Not surprisingly, new entrants have shown little interest in competing for such customers.

At the end of the day, the FCC's effort to create a competitive telecom sector yielded only the illusion of competition. Indeed, the collapse of the CLECs is at the very core of the Nasdaq meltdown that began in August. Investors, smarting from the collapse of the "dot.com" stocks this spring, started taking a hard look at the CLEC sector this summer and they did not like what they saw.

Few of any of these companies were making money, and virtually all had business plans that depended on the regulatory largess of the FCC. Like the dot.coms, they had made promises about growth and profitability they simply could not keep. High-flyers like Covad, Northpoint, RCN, Teligent and Winstar saw their market valuations virtually disappear in a matter of a few weeks. Unable to compete in the residential market, even big companies like AT&T; and MCI had to scale back their promises and their plans for building out competitive networks.

By December 2000, the rout was complete. The CEO of one major CLEC was quoted as predicting that "out of the 45 or so publicly traded CLECs … half of them probably won't be here next year."

Last week, Northpoint declared bankruptcy, becoming the first major casualty of a policy that was doomed from the beginning. The collapse of the CLECs has already had broad consequences for the IT sector. At companies like Cisco, Lucent, Nortel and Motorola, the collapse of the CLECs showed up first in the form of late payments and ultimately bad debt. Reduced sales projections and predictions of lower profits and even losses were close behind.

But this is only the beginning. Thanks to convergence, what happens in telecom directly affects the entire computer and Internet sector of the economy. The next generation of Internet content and applications depends on ubiquitous, affordable broadband services. And the next generation of personal computer and software sales depends on the next generation of applications. No broadband means no applications, and that means no need for new computers, new chips and new software.

The new chairman of the FCC, Michael Powell, understands all this quite well. He was among the first to see, and to warn of, the CLEC's tendency to rely too heavily on regulatory largess, and even told a CLEC convention in 1998 that, "Relying too heavily on current regulatory distortions can provide short-term benefits, but it also perpetuates these and other distortions that will not necessarily benefit you over time." Mr. Powell's words were not heeded then, either by the CLECs or by the commission. Now, as in so many areas, it falls to the new administration to clean up the mess its predecessors left behind. At the FCC, President Bush has the right man for the job.

Jeffrey A.Eisenach is president of the Progress & Freedom Foundation and an author of "The Digital Economy Fact Book." The views expressed here are his own.

Jeffrey A.Eisenach is president of the Progress & Freedom Foundation and an author of "The Digital Economy Fact Book." The views expressed here are his own.

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