After booming in the second half of the 1990s, the telecom industry has fallen on hard times. Hundreds of large and small telecom firms that attempted to compete with the incumbent local exchange carriers (ILECs) have gone broke. Others are close to that fate. The ILECs blame this outcome on the CLECs (competing exchange carriers). The CLECs blame it on the ILECs. While the two sides and their supporters have been arguing, a ray of light has started to shine at the end of the industry's tunnel. The market share of new entrants has finally begun to increase sharply.
Is that increase a temporary phenomenon or a sign that markets are evolving as economic theory would predict? As demonstrated in this paper, strengthening competition in the telecom sector is the key to restoring telecom investment. Doing so has ramifications that range far beyond that particular sector. About two-thirds of our economy’s growth is driven by innovations in information technology. Telecom plays an essential role in information acquisition and dissemination and accounts for the lion’s share of IT investment and innovation. A vibrant telecom sector is thus vital to the short and long-term success of the economy.
This paper reaches its pro-competitive conclusions after considering the empirical evidence, reviewing basic lessons about monopoly behavior, and exploring a more realistic model of the industry and telecom policy. The empirical evidence connecting competition to telecom investment is striking. During 1996-2000, over a third of gross investment was done by the CLECs even though their revenue was only one fifteenth that of the ILECs.3 In 2000, at the peak of the investment boom, CLECs invested $25 billion, which almost matched the $27 billion of gross ILEC investment.
Kevin A. Hassett is a resident scholar at AEI. Laurence J. Kotlikoff is chairman of the Department of Economics at Boston University and a research associate at the National Bureau of Economic Research.