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The Broadband Problem: Anatomy of a Market Failure and a Policy Dilemma

The Broadband Problem: Anatomy of a Market Failure and a Policy Dilemma

by Charles H. Ferguson

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As the Internet revolution continues to unfold and transform telecommunications, pressure is building for faster, less expensive, and more widely accessible broadband service. Such a development would facilitate improved and less expensive traditional applications such as voice telephony and web browsing. It would also enable new and useful applications such as


As the Internet revolution continues to unfold and transform telecommunications, pressure is building for faster, less expensive, and more widely accessible broadband service. Such a development would facilitate improved and less expensive traditional applications such as voice telephony and web browsing. It would also enable new and useful applications such as Internet-based television, videoconferencing, and software distribution. Broadband has great potential to improve efficiency and productivity, even to improve national security in some cases. Broadband service and affordability, however, have consistently lagged well behind demand and progress in information technology, with damaging results. The Internet revolution remains incomplete and threatens to stagnate if the situation continues. In The Broadband Problem, economist and technology entrepreneur Charles H. Ferguson explains the causes and ramifications of this damaging bottleneck, and he offers suggestions on improving the current state of affairs. He asserts that current telecommunications law and policy have not provided sufficient levels of new entry, competition, and innovation in the local telecom market. The continuing dominance of ILECs (incumbent local exchange carriers) in that market impedes the healthy, and much-needed, development of an efficient broadband market. The result of these policy and market failures is inadequate technological progress, innovation, and productivity in advanced Internet services and telecommunication services generally. The broadband problem is holding us back, and thus must be addressed and solved. With this important volume, Charles Ferguson has contributed mightily to that mission.

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The Broadband Problem

Anatomy of a Market Failure and a Policy Dilemma
By Charles H. Ferguson

Brookings Institution Press

Copyright © 2004 Brookings Institution Press
All right reserved.

ISBN: 0-8157-0644-8

Chapter One


"In the long run, we're all dead." -John Maynard Keynes

Of all the factors blamed for the U.S. economy's recent problems, one that has received insufficient attention is the failure of the local telecommunications industry to provide rapid technological progress and cost reductions in the high-speed data communications services necessary to an advanced information economy. These services-which include high-speed Internet service, videoconferencing, and video delivery-are becoming essential to businesses and consumers alike. Yet ten years after the advent of the Internet revolution, the broadband situation remains quite unsatisfactory. The problem isn't technology; it is the failure to deploy it. In January 2002, the Committee on Broadband Last Mile Technology of the National Research Council published a report which contains, in its summary and recommendations, the following passage:

"Finding 6.6. Unlike the underlying communications technologies, the capabilities of deployed broadband are not on a Moore's law-like curve.

"Unfavorable comparisons are sometimes made between sustained improvements in the performance-to-price ratio of computing and lagging improvements in the capacity of broadband local access links. From this perspective ... local access links are a bottleneck. The communications technologies themselves ... have in fact kept pace with or surpassed improvements in computing. The gap that exists is between deployed access technology and computing technology ..." (Italics in original.)

Computer industry experts agree that broadband services are being deployed too slowly. In the following pages I argue that the "broadband problem" is the result of a form of "crony capitalism" in what has remained largely a monopoly industry, one of the last in the United States. Its practices have reduced productivity growth, increased U.S. dependence on imported energy, worsened the recession in the telecommunications and information technology sectors, and impeded progress in fields ranging from education to national security. The macroeconomic effects on GNP and productivity growth, though impossible to measure precisely, are probably quite large.

The broadband problem has had such a large impact for two main reasons. First, the utility of all information systems is becoming increasingly dependent upon Internet-based communication between them, while progress in Internet services, in turn, is becoming increasingly dependent upon broadband telecommunications. Second, all digital information technologies display "Moore's law" behavior, also known as the "technology curve," which refers to exponential improvement in performance delivered at a given cost, with this ratio doubling every twelve to eighteen months. This behavior was first identified in the 1970s by Gordon Moore, one of the founders of Intel. With some variations in exact rates of change, this pattern of exponential improvement has been confirmed not only in semiconductors but also in all digital information technologies and industries, ranging from personal computers to telecommunications switching, software algorithms, digital cameras, fiberoptic communications channels, disk drives, and laser printers. The nature of exponential growth, together with the high rates of progress exhibited by digital technology, implies that the levels of performance per unit cost delivered by all of these digital systems improves by a factor of 50 to 100 every decade. Current personal computers, for example, are far more powerful than the most expensive and powerful computers in the world forty years ago. In most industries, this progress in underlying technology is directly translated into comparable rates of improvement in products and services.

There is, however, one major technology sector that does not exhibit this pattern: local telecommunications, the so-called last mile that connects the switching and distribution centers of local telecommunications and cable television companies to the users of broadband services (houses, apartment buildings, businesses, schools, government agencies, and so forth). Whereas long-distance broadband services have generally exhibited Moore's law behavior, delivering rapid and consistent improvements in price-performance ratios since the mid-1980s (once the long-distance industry became highly competitive following the divestiture of AT&T in 1984), local telephone and cable TV services have improved slowly at best. Not coincidentally, these services are still in the hands of monopolies. This failure to deliver rapid technical progress includes residential broadband services (asymmetric digital subscriber line [ADSL] and cable modem service), which have not significantly improved their price-performance ratios or technical quality since their introduction in the late 1990s. The static nature of last-mile services has become a chronic problem for American high technology, and for the American economy.

The Unfinished Business of High Technology

A prominent feature of the U.S. telecommunications environment is that most homes and small businesses still depend on modems with maximum speeds of less than 60 kilobits per second (kbps) to access the Internet. In the late 1990s modem speeds reached technological limits imposed by local telephone networks, after many years of rapid improvement. The slow rate and high price at which faster services have been deployed has resulted in reduced technical progress and low rates of broadband usage (for example, far behind Canada and South Korea). In 2003, about 60 percent of U.S. households had Internet access. Of these, about two thirds still depended upon modems, while only one third-and thus only about 20 percent of total U.S. homes-use faster Internet access, based primarily upon cable modems (provided by cable television vendors) and secondarily by ADSL (provided over telephone lines). Even these services, while faster than modems, are quite slow compared with speeds that computers are already capable of, and that technology can now deliver. Current residential "broadband" services typically deliver only about 1 megabit per second "downstream" to homes and 128 kilobits per second "upstream" to the Internet. This is far less than true (and technically feasible) broadband speeds, and the structure of these services further reduces their utility.

Slow residential Internet access is but the tip of the problem, however. The broadband problem in fact encompasses a host of other services as well. Owing to the exponential progress of digital communications technology, all of these services should be experiencing high rates of innovation and of price-performance and quality improvement-as is the case in all other information technology sectors, such as the semiconductor, computer, software, consumer electronics, corporate networking, and long-distance telecommunications services industries. Instead, nearly all local communications services-including voice telephony, cable television, business data services, Internet access, and others-are exhibiting low, and in some cases even zero or negative, rates of technological progress, a condition which has persisted for a decade and which shows few signs of changing. This astonishing situation, virtually unprecedented in digital information technology, has major implications for U.S. economic growth, national security, and energy policy. For reasons described shortly, broadband deployment is the key to understanding and changing it.

Corporate and Political Behavior

Since the late 1990s, corporate scandals have engulfed the United States. Many of the businesses involved in these scandals-Enron, WorldCom, Adelphia, Tyco, Global Crossing, Homestore.com, HealthSouth, energy companies implicated in the California power crisis, accounting firms, investment banks, mutual funds, the New York Stock Exchange, ImClone-have been taken to task for explicit abuses such as accounting fraud or major failures of corporate governance. Questionable practices in the local telecommunications industry are more subtle, though similar to these other scandals in certain respects, such as poor corporate governance and the use of lobbying to prevent stringent regulatory oversight. Much of their behavior has been perfectly legal, although the incumbent local exchange carriers (ILECs) certainly appear to have violated the antitrust laws. The industry's disturbing conditions include the prevalence of monopoly power, cooperation between firms possessing regional monopolies, the strategic use of campaign contributions for political influence, corporate payments to academic policy experts, litigation directed against competitors, and loopholes in antitrust and regulatory policies.

Equally worrying are the enormous social and economic costs of these practices. According to some estimates, they far exceed those of scandals such as Enron and WorldCom, which together amounted to a one-time loss of perhaps $37 billion to $42 billion from the U.S. gross domestic product (GDP). Between them, U.S. local telephone and cable television companies control the deployment of local broadband technology to both homes and businesses, and directly represent roughly $175 billion in annual revenues. These revenues would be deeply threatened by rapid, competitive local broadband deployment and more generally by the rise of Internet-based telecommunications services. Consequently, through a combination of inefficiency, cartelistic conduct, and rational monopoly behavior given their current incentives, both the ILEC and CATV (cable television) industries (particularly the former) are deploying broadband technology slowly and in ways designed to protect their established, increasingly obsolete, businesses.

As a result, broadband service has become a major impediment to U.S. and even world economic growth. This may seem implausible, given the industry's relatively small size. Total U.S. broadband revenues will be less than $50 billion in 2003, a trivial sum in a $10 trillion economy. However, as with personal computers in the 1970s and the Internet in the 1980s, the broadband industry is far more important than its current size would suggest. Local broadband deployment is now the most critical driver both for improvement in conventional voice telecommunications services and for the future progress of data communications and the Internet. The Internet, in turn, is the most important enabler of productivity growth and of new products, services, and applications in many other industries. Despite the Internet-related financial bubble and crash of 1995-2002, the Internet unquestionably helped reignite U.S. productivity growth in the 1990s and constitutes an enormous industrial, social, educational, political, and even military revolution. In most respects, this revolution has thus far progressed faster than any other innovation in economic history. However, its further progress depends increasingly upon broadband services.

In the coming decade, therefore, broadband policy could be comparable in importance to macroeconomic or fiscal policy in promoting or retarding U.S. GNP growth and living standards. The same probably holds for the effect of broadband policies on the economies of many other nations, both developed and developing. As I indicate in chapter 2, the economic costs of constraints to broadband deployment have already been large and could amount to hundreds of billions of dollars over the next decade, possibly reaching $1 trillion. In the event of a major national emergency affecting physical transportation, such as an act of biological or nuclear terrorism, these costs could be far larger.

The industry's current problems exist despite a grand attempt to reform the local telecommunications industry, via the Telecommunications Act of 1996. In conjunction with the Internet revolution, this law generated great optimism: a new, dynamic, and competitive local telecommunications industry seemed ready to flourish, poised both to provide and consume broadband services. As the Internet bubble expanded in the late 1990s, telecommunications carriers made enormous investments in long-distance broadband capacity, and a large number of new competitive local exchange carriers (CLECs) were created. Some-such as Covad, Northpoint, RCN, McCleod, Williams, and many others-raised large amounts of capital regardless of the sustainability of their business, technical, and competitive plans. These plans were in fact not sustainable, in part due to the resistance of the ILECs. After the NASDAQ crash, most of these firms went bankrupt or contracted sharply; some were even absorbed or controlled by the dominant incumbents. In the absence of improved policy, the recession in the telecommunications, Internet, and computer industries could last for many years, with major effects on the U.S. economy.

Economic Impact of Information Technology

The information technology (IT) sector is now one of the fundamental drivers of the U.S. economy, accounting for about half of all U.S. capital spending and driving the majority of U.S. productivity growth. Most of the IT sector is very competitive and delivers extremely high rates of innovation and technical progress-usually in excess of 40 percent per year, and often 75 percent per year or more. Also important, personal computing and the Internet have made the entire U.S. economy (and U.S. firms operating in the global economy) far more productive. Since 1994, when the Internet was privatized, Internet-related activities have displayed the highest rates of growth and technical change within the IT sector and U.S. capital investment.

From the end of World War II through the late 1960s, U.S. productivity growth averaged more than 3 percent a year. Starting with the first oil shock of 1973, however, there followed two decades of near stagnation, during which U.S. productivity grew less than 1 percent a year, a condition shared to varying degrees by all Western economies. This period also saw the rise of Japanese and Asian industrial competition; the competitive decline of mature U.S. industries such as automobiles, traditional consumer electronics, and steel; increased long-term unemployment and inflation; declining real wages; and sharply increasing trade, payments, and fiscal deficits in the United States. In this pre-Internet period, information technology was a growing but still minor fraction of U.S. capital investment. Then, in the mid-1990s, U.S. productivity experienced a sharp recovery, thanks in large part to IT and the Internet revolution, and subsequently U.S. productivity growth has averaged about 2.5 percent a year. Even following the 2001 recession, the 9/11 attacks, huge federal deficits, and a weak economic recovery, productivity growth has remained robust and in fact has increased.

Continued U.S.


Excerpted from The Broadband Problem by Charles H. Ferguson Copyright © 2004 by Brookings Institution Press . Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Meet the Author

Charles H. Ferguson is a nonresident senior fellow in Economic Studies at the Brookings Institution and an independent computer consultant. He is author of High Stakes, No Prisoners: A Winner's Talk of Greed and Glory in the Internet Wars (Times Books, 1999) and coauthor with Charles R. Morris of Computer Wars: The Fall of IBM and the Future of Global Technology (Random House, 1993). He founded and served as CEO of Vermeer Technologies, the company responsible for developing FrontPage.

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