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Crandall/Alleman CONTRIBUTORS George Bittlingmayer, University of Kansas Gerald R. Faulhaber, University of Pennsylvania Austan Goolsbee, University of Chicago Robert W. Hahn, American Enterprise Institute Jerry Hausman, Massachusetts Institute of Technology Thomas W. Hazlett, Manhattan Institute Broadband Charles L. Jackson, JTC Donald J. Kridel, University of Missouri, St. Louis Broadband Bruce M. Owen, Economists Incorporated Paul N. Rappoport, Temple University Howard Shelanski, University of California, Berkeley Timothy J. Tardiff, National Economic Research Associates Lester D. Taylor, University of Arizona Hal Varian, University of California, Berkeley Robert W. Crandall is a senior fellow in the Economic Studies program at the Brookings Institution. His previous books include (with Martin Cave) Telecommunications Liberalization on Two Sides of the Atlantic (Brookings, 2001) and (with Leonard Waverman) Who Pays for Universal Service? (Brookings, 2000). James H. Alleman is director of research at the Columbia Institute of Tele-Information, and a visiting associate pro- fessor in the Columbia Business School, on leave from the Interdiscipli- nary Telecommunications Department at the College of Engineering and Applied Science, University of Colorado, Boulder. American Enterprise Institute for Public Policy Research 1150 Seventeenth Street, N.W. Washington, D.C. 20036 The Brookings Institution 1775 Massachusetts Avenue, N.W. Washington, D.C. 20036 Cover design by Terry Patton Rhoads 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page iii Broadband Should We Regulate High-Speed Internet Access? Robert W. Crandall James H. Alleman Editors - Washington, D.C. 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page iv Copyright © 2002 by AEI-Brookings Joint Center for Regulatory Studies, the American Enterprise Institute for Public Policy Research, Washington, D.C., and the Brookings Institution, Washington, D.C. All rights reserved. No part of this publication may be used or reproduced in any manner whatsoever without permission in writing from the AEI-Brookings Joint Center, except in the case of brief quotations embodied in news articles, critical articles, or reviews. Broadband may be ordered from: Brookings Institution Press 1775 Massachusetts Avenue, N.W. Washington, D.C. 20036 Tel.: 1-800-275-1447 or (202) 797-6258 Fax: (202) 797-6004 www.brookings.edu Library of Congress Cataloging-in-Publication data Broadband: should we regulate high-speed internet access?/Robert W. Crandall and James H. Alleman, editors. p. cm. Papers from two conferences: one held by AEI-Brookings Joint Center for Regulatory Studies, Oct. 4–5, 2001 and the other by Columbia University Center for Tele-Information in New York. ISBN 0-8157-1592-7 (cloth : alk. paper) — ISBN 0-8157-1591-9 (pbk. : alk. paper) 1. Telecommunication policy—United States. 2. Internet—Government policy—United States. 3. Internet users—United States. 4. Broadband communication systems—United States. I. Crandall, Robert W. II. Alleman, James H. III. AEI-Brookings Joint Center for Regulatory Studies. HE7781 .B747 2002 384.3'3—dc21 2002012472 9 8 7 6 5 4 3 2 1 The paper used in this publication meets minimum requirements of the American National Standard for Information Sciences—Permanence of Paper for Printed Library Materials: ANSI Z39.48-1992. Typeset in Adobe Garamond Composition by Circle Graphics Columbia, Maryland Printed by R. R. Donnelley and Sons Harrisonburg, Virginia 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page v Foreword conomists are now beginning to recognize that the E“new economy” could have a pronounced effect on economic growth. There is still great debate about how large this effect will be and what form it will take. At the center of the new economy is the Internet. One of the critical policy issues facing the country is how to reg- ulate the Internet, particularly the delivery of high-speed, or “broadband,” services. In this volume, experts examine the economic potential of broad- band and evaluate different approaches to its regulation. Broadband could be a key driver in the economy for both consumers and businesses. It is likely to provide new ways for consumers to acquire information, enjoy audio and video entertainment, monitor remote loca- tions, receive medical care, and engage in business transactions. In addi- tion, broadband could provide businesses with new opportunities to reduce their costs and to reach consumers with products and services. These benefits are likely to be very large as broadband spreads over the nation’s households. Some research suggests potential economic benefits of hundreds of billions of dollars annually. There is no guarantee, however, that the full potential of broadband services will be realized. The success of this new service depends on whether the firms that must make huge investments to develop networks have the opportunities to earn returns commensurate with the risks they face. Firms making such investments operate in the highly regulated com- munications sector. Telephone and cable companies have been subject to regulation by federal, state, and even local authorities for decades. The 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page vi regulation of broadband poses challenges for countries around the world. A central policy question is whether different providers of broadband ser- vices should be regulated differently, as is currently the case in the United States, where broadband services are provided by phone companies, cable companies, and satellite services under very different regulatory regimes. The degree and type of regulation that communications companies face in the delivery of new broadband services could play an important role in determining whether they can earn adequate returns on the investments required to deliver these services. This collection of essays provides a state-of-the-art analysis of the eco- nomics of broadband. It is the result of a conference held by the AEI- Brookings Joint Center for Regulatory Studies on October 4–5, 2001, and also includes two essays presented at a later conference at Columbia University. The scholars who participated in these conferences reflected diverse points of view. Some saw broadband as a relatively unimportant phenomenon, while others thought it would be quite significant. Some believed that the form of regulation was not critical to the rate of diffusion of broadband, while others thought that regulation could have a substan- tial impact on the rate of diffusion. The volume editors wish to thank Daniel Puskin for research assis- tance, Diane Hammond for editing the manuscript, Gloria Paniagua for verifying its factual accuracy, Inge Lockwood for proofreading the pages, Robert Swanson for providing an index, and Donald Tench IV for con- ference planning and logistical assistance. This volume is one in a series commissioned by the AEI-Brookings Joint Center for Regulatory Studies to contribute to the continuing debate over regulatory reform. The series addresses several fundamental issues in regulation, including the design of effective reforms, the impact of pro- posed reforms on the public, and the political and institutional forces that affect reform. We hope that this series will help illuminate many of the complex issues involved in designing and implementing regulation and regulatory reforms at all levels of government. The views expressed here are those of the authors and should not be attributed to the trustees, officers, or staff members of the American Enterprise Institute or the Brookings Institution. . . AEI-Brookings Joint Center for Regulatory Studies 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page vii Contents 1 Introduction 1 . . 2 Broadband Mysteries 9 . 3 The Demand for Bandwidth: Evidence from the INDEX Project 39 . 4 The Demand for Broadband: Access, Content, and the Value of Time 57 . , . , . 5 Wired High-Speed Access 83 . 6 From 2G to 3G: Wireless Competition for Internet-Related Services 106 7 Internet-Related Services: The Results of Asymmetric Regulation 129 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page viii 8 Competition and Regulation in Broadband Communications 157 . 9 Regulation and Vertical Integration in Broadband Access Supply 197 . 10 Broadband Deployment: Is Policy in the Way? 223 . 11 The Financial Effects of Broadband Regulation 245 . 12 Subsidies, the Value of Broadband, and the Importance of Fixed Costs 278 13 The Benefits of Broadband and the Effect of Regulation 295 . , . , . Contributors 331 Index 333 0894-00-Brkgs/Crandall FM 11/06/02 14:39 Page ix Broadband 0894-01-Brkgs/Crandall 11/06/02 14:39 Page 1 . . 1 Introduction he 1990s was the decade of the Internet and the Tstock market bubble, two phenomena that were likely related. After the bubble burst and the stock market settled down to more normal levels, economists began to measure the real effects of the information technology revolution on the economy—and were often pleasantly surprised. Productivity growth accelerated in the late 1990s, fed in large part by investments in information technology and the growth of the Internet. Some fear, however, that public policy may be impeding the development of the Internet into a high-speed communications network capable of delivering full video images, complicated games, and com- prehensive audio entertainment. In the absence of a wide diffusion of high-speed Internet connections, the demand for information tech- nology equipment and new Internet service applications has remained