The enduring lessons of the breakup of AT&T: a twenty-five year retrospective.(Introduction)

On April 18-19, 2008, the University of Pennsylvania Law School hosted a landmark conference entitled "The Enduring Lessons of the Breakup of AT&T: A Twenty-Five Year Retrospective." (1) This Conference was the first major event for Penn's newly established Center for Technology, Innovation, and Competition (CTIC), a research institute committed to promoting basic research into foundational frameworks that will shape the way policymakers think about technology-related issues in the future.

The breakup of AT&T represents an ideal starting point for examining the major threads of telecommunications policy that have emerged over the past quarter century. Although the Federal Communications Commission (FCC) had already begun implementing many of the measures eventually incorporated into the consent decree that settled the case, commonly known as the Modification of Final Judgment (MFJ), (2) the divestiture of AT&T's local operating companies and the accompanying mandate to provide equal access to all long-distance and information service providers (ISPs) nonetheless represents the major milestone in the attempt to promote greater competition in the telecommunications industry.

The Conference brought together what one attendee called "the most distinguished group of telecommunications scholars ever assembled in one room." The final conference lineup included two former FCC Commissioners, six former FCC Chief Economists, and four former Heads of Economic Analysis of either the Justice Department's Antitrust Division or the Federal Trade Commission (FTC). Many of the panelists and moderators played key roles in shaping the policy either as members of the Justice Department staff that litigated the case or of the FCC staff charged with implementing the decree and integrating it into the regulatory regime governing telecommunications. The conference was attended by distinguished scholars as well as staff from the FCC and the FTC interested in telecommunications and antitrust policy. This unique combination of subject matter, presentations, and audience made for a very memorable event.

I. LOOKING BACK AT DIVESTITURE: WHAT WORKED.'? WHAT DIDN'T?

The initial panel brought together a distinguished group of people who played key roles in the AT&T litigation. Their presentations offered differing opinions about whether the breakup of AT&T represented a policy success or a policy failure, as well as which aspects of the breakup played out as expected and which aspects emerged as surprises.

Roger Noll, who helped develop the government's case against AT&T, noted how that case sharpened the debate between, and improved the quality of research into, the optimistic and pessimistic visions of the perfectibility of regulation and whether antitrust can compensate for regulation's shortcomings. In addition, the experience implementing the breakup of AT&T revealed that antitrust courts were no better at dealing with anticompetitive behavior than were regulators. Noll nonetheless suggested that the emergence of a competitive Internet and wireless industry would have been delayed if the court had not mandated equal access to and interconnection with the local telephone network.

Paul MacAvoy, who was one of the defense experts in the government's case against AT&T, focuses on an anomaly of divestiture: the price of long-distance service relative to marginal cost (also known as the Lemer Index) surprisingly increased after divestiture and increased still further following the enactment of the Telecommunications Act of 1996 (1996 Act). This fact suggests that these measures may not have been as successful in promoting meaningful competition in the telephone industry as generally thought.

Alfred Kahn, who served on AT&T's National Advisory Board during the early stages of the case, observed that the vision of promoting competition through vertical disintegration underlying the breakup of AT&T was not realized until after the enactment of the 1996 Act. He believes this has been unfairly maligned. Kahn found the same issues are being replayed in the debates over network neutrality, which he called a "terrifying abomination." The better solution, in Kahn's opinion, is to promote the emergence of a third independent Internet access provider, most likely in the form of wireless.

Joseph Weber was the Director of Network Architecture Planning for AT&T. He helped craft the MFJ's technical appendix, oversaw much of the actual implementation of the divestiture, and provided an overview of the regulatory and historical background for the case. He speculated that the real impetus for competition was technological change, which in turn suggested that competition would have emerged even if divestiture had never occurred.

II. EQUAL ACCESS AS THE NEW REGULATORY PARADIGM: THE TRANSITION FROM RATE REGULATION TO ACCESS REGULATION

The breakup of AT&T was a landmark in the shift away from rate regulation, which grants customers access to the entire network, toward access regulation, which grants competitors access to portions of the network. Another panel explored the successes and the new challenges posed by this new regulatory paradigm, examining its workability, its impact on static and dynamic efficiency, and the extent to which it now serves as a model for other countries and industries.

Glen Robinson, an FCC Commissioner during the early stages of the government's suit against AT&T, noted that both the MFJ and the 1996 Act reflected the belief that new entrants would use access to the incumbent's network as a stepping stone to full-fledged, facilities-based competition. The mounting empirical evidence indicates that this dynamic has failed to materialize. He further observed that the reduction in regulation that many thought would accompany the shift to a new regulatory paradigm based on access regulation has also failed to materialize.

Tim Wu offered a distinction between two types of access mandates. On the one hand are zero-price rules, which include the rules governing customer premises equipment (CPE), the regime established by Computer 11, (3) and the network neutrality conditions imposed on the AT&T/BellSouth merger. On the other hand are access fee rules, which include long-distance access charges and unbundled network element (UNE) access under the 1996 Act. Wu argues that zero-price rules are more effective in creating markets that operate without requiring any cooperation from the incumbent.

As a presenter, I pointed out that the current approach to access regulation fails to take into account the different ways particular networks are configured or to take into account the interactions among network components that allow networks to compensate for unexpected changes in demand by rerouting traffic through different portions of the network. Presenting this joint work with Daniel Spulber, I offered a model of network regulation based on the branch of mathematics known as "graph theory" that captures the way in which networks constitute complex systems. This approach holds the promise of unifying the different types of access to local telephone networks into a single, overarching framework that can provide insights into optimal network configuration, cost, capacity, and reliability, as well as a basis for determining the likely impact of different types of access mandates.

Former FCC Chief Economist Gerald Faulhaber observed that access regulation requires the continued imposition of rate regulation for an extended period of time. He also offered a theory of successful access regulation that depends on one of two conditions being met. Either the access interface must be simple and easy to monitor or the incumbent must not compete directly with new entrants in downstream markets.

III. KEYNOTE ADDRESS BY THE HONORABLE RICHARD A. POSNER

In his keynote address, Judge Richard Posner described the role he played both as General Counsel of President Johnson's Task Force on Communications Policy--which, as Roger Noll noted, initiated the analysis that established the groundwork for the government's case against AT&T--and as a consultant to AT&T during the early stages of the case. His witty observations and reflections yield the type of insights into how AT&T's internal culture and decision making shaped its response to the case that only a person who was actually there can provide.

IV. STRUCTURAL SEPARATION IN DYNAMIC MARKETS: LESSONS FOR THE INTERNET, LESSONS FOR EUROPE

Recent developments, most notably the Microsoft litigation, the Verizon/MCI and SBC/AT&T mergers, and the European Commission's review of its e-communications regulatory framework have given new emphasis to debates over the effectiveness of structural separation as a remedy. This panel explored the insights that the breakup of AT&T provides into the relative merits of structural separation and vertical integration, as well as the unique problems that structural separation poses.

Joseph Farrell, who served as FCC Chief Economist during the implementation of the 1996 Act and as Deputy Assistant Attorney General for Economic Analysis for the Justice Department's Antitrust Division, suggested that the complexity of the economics of vertical integration may make it hard for business executives to discern the true incentives. He further suggested that modern competition policy may have become a bit too doctrinaire in focusing on incentives, and in so doing, has overlooked the potential value of openness, diversity, and imagination.

Eli Noam offered insight into the current debate over structural separation taking place in Europe by presenting data comparing the performance of the U.S. telecommunications industry to Canada's, which achieved similar results without undergoing a breakup of the incumbent. The similarity of outcomes raises serious questions about the necessity and efficacy of structural separation as a remedy.

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