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From the Telecom Industry to Academia
He first became interested in these issues at Bell Laboratories
in the 1960s. As a freshly minted mathematics grad Faulhaber
helped develop real-time switching systems for the phone company.
After earning his master’s in math, he moved into operations research, applying queuing theory and congestion theory to make the phone network run more efficiently. In those days, the Bell System enabled scientists and engineers to pursue their pet projects and even earn advanced degrees on the company’s dime, but the government had begun to ask whether the Bell monopoly was the right way to organize the telephone industry.
That question sparked Faulhaber’s interest in the economics of the networks, and, while still a Bell Labs employee, he went on to earn a PhD in economics from nearby Princeton. He then joined a new applied economics group within Bell Labs; the only social scientists among hundreds of hard scientists, the economists were an object of envy and suspicion. “How come they’re getting all this attention when the physicists and engineers are pulling the system together?” some asked. So after the government’s painful breakup of Ma Bell, many blamed the company’s woes on the economists, Faulhaber recalls, “who came in with their flapdoodle ideas about competition.”
One of Faulhaber’s landmark papers gleans lessons about effective and ineffective policy from the federal government’s checkered attempts to regulate telecom services. “Generally people think if you don’t like something that’s happening, you can pass a law to make it stop,” he says. “But the fact is, some laws are unenforceable — or enforceable at large cost.” That’s what happened when, in an early attempt to force AT&T to open up long distance to competition, the Federal Communications Commission (FCC) mandated that AT&T lease its private lines to other carriers, such as MCI and Sprint. There were all sorts of ways AT&T’s local access providers could subvert this rule, hampering potential competitors without catching the eye of regulators. In general, says Faulhaber, “if what you want a company to do is easily measured, and it’s easy to see when the law’s been violated, and there’s no tricky stuff involved” — that’s when you can pass effective laws. If, on the other hand, the technology or the relationship you’re trying to control is too complex, regulations can create more problems than they solve.
A major unintended consequence: encouraging firms to engage in what economists call “rent-seeking,” or focusing on regulatory moves and countermoves, Faulhaber says. “Once you set up a system where it pays to complain — which is what regulation does — everybody complains about everybody else. This goes on all the time at the FCC. The telephone companies do it; the cellular companies do it. That’s how the game is played.”
In 1984, soon after the Bell System’s divesture, Faulhaber accepted an offer from Wharton. He was burned out on telecom and eager to pursue other research interests, he says, and didn’t return to serious work on telecom issues until the early 1990s, when people started looking “at this new thing called the Internet.” He was intrigued: “It relates to telecom; maybe I should look at it,” he remembers thinking. There was an interesting tension, too: the telecom industry was highly regulated, and the Internet was just the opposite — yet the two were tightly intertwined.
At the peak of the dot-com boom, Faulhaber would come to deal with this tight connection in a big way. In 2000, the FCC tapped him for a one-year post as the agency’s Chief Economist, thrusting him into an anti-trust debate about a proposed merger between AOL and Time-Warner — the biggest corporate merger in U.S. history. Naturally, the Federal Trade Commission (FTC) was deeply involved, but because of radio-license transfers, so was the FCC. The two agencies came up with strikingly different answers because, Faulhaber says, they were looking at different theories of anti-trust: bottlenecks and bandwagons.
“If some company owns a bottleneck that somebody needs access to, then anti-trust laws sometimes force that bottleneck to be opened,” explains Faulhaber. With AT&T, the government had concluded that the company’s exclusive ownership of the local-loop bottleneck gave AT&T anti-competitive advantage in long-distance service, hence the forced divestiture. Access to bottleneck facilities exists “all over anti-trust law,” adds Faulhaber — in industries as varied as railroads, funeral homes, and ski lodges. And that’s how the FTC viewed the AOL/Time-Warner merger: since Time-Warner’s cable facilities would enable AOL to easily offer broadband Internet access, AOL could end up as the only broadband provider, the FTC feared.
Under Faulhaber’s leadership, the FCC’s economists took a different tack. Instead of focusing on the cable bottleneck, they looked at AOL’s instant messaging service. Since AOL’s instant messaging customers can use the service to communicate only with other AOL customers, the service is subject to “network effects,” otherwise known as bandwagons. The idea: the network with the largest number of customers is the most valuable. As the biggest bandwagon in the online auction business, for example, eBay benefits from network effects since sellers want to do business where all the buyers are — and vice versa. With instant messaging or other communication service, several companies can interconnect — but if you’re the biggest gorilla in the business, then it’s not in your interest to connect your network to anyone else’s. Because of network effects, Faulhaber says, a powerful company can use the refusal to interoperate as an anti-competitive weapon.
The FCC’s solution was a carefully constructed condition on the merger to prevent the corporate behemoth from unfairly exploiting network effects — but without hurting the company if they did nothing wrong. “You have tremendous power in the government, and you don’t just bandy it about,” says Faulhaber. |
