A Brief history of Internet regulation
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POLICY MEMO
A Brief History of
Internet Regulation
By Ev ehrlich March 2014
Executive Summary From the beginning of “community antenna
Proposals to regulate the Internet are often TV” through the 1990s, a parallel but more
presented as “new” solutions to deal with limited effort was made to regulate the nascent
modern problems, but the most significant of cable industry. While these regulations had
these proposals, such as “network neutrality” some success, technological change quickly
and common carrier rules on unbundling outstripped them—both in the telephone business
and interconnection, are actually vestiges and the emerging field of high-speed data—and
of long-outmoded ways of thinking about a bipartisan consensus formed in the early 1990s
telecommunications policy. This paper explores that additional steps were needed to promote
the relevant regulatory history, offering critical competition in all these arenas.
context to today’s Internet policy debates.
The result was the Telecommunications Act of
From the early days of the AT&T monopoly well 1996, watershed legislation that marked the end
into the 1990s, regulators, the courts and the of the telephone age and the beginning of the
Congress engaged in a lengthy effort to protect Internet age from a policy perspective. The Act
consumers and ultimately bring competition embraced and codified the FCC’s distinction
into the markets for local and long-distance between traditional telephony/telecommunications
telephone service. This included strict “common services and the emerging world of information
carrier” utility regulations and mandatory services, with strict common carrier rules limited
interconnection requirements and ultimately to the former. On the telephone side, this meant
the 1984 Modified Final Judgment, which forced a stifling regime of mandatory “unbundling” and
the breakup of AT&T into regional Baby Bells. rigid price controls, while giving the private
About the author
Ev Ehrlich is a senior fellow at the Progressive Policy Institute and the president of ESC Company.
Policy Memo Progressive Policy Institute
sector more latitude to innovate and invest on Ultimately, three key lessons emerge from this
the “information services” side. The 1996 Act may policy review. First, information services and
not have specifically contemplated the rise of the telecommunications services really are different,
broadband Internet (the idea of an “information and broadband has flourished as an information
superhighway” was in the air, but the exact form service free from ill-fitting and stifling common
it would take was still unclear as a matter of carrier constraints. Second, investment and
both technology and policy), but by protecting capital flow to where regulation (or the absence
information services from the common carrier thereof) encourages them to flow. And third,
framework, the Act set the stage for the dynamic technology, business models, and consumer
growth we have seen in American broadband. behaviors change and, as they change, the
meaning and effect of different regulatory
The result was a boom in cable broadband proposals change as well.
investment that telecommunications providers
attempted to counter by offering DSL services. Introduction
But any new DSL capability they constructed An active public policy debate is underway
had to be leased out to competitors at below regarding Internet regulation. At its core lie
market prices under the unbundling regime, a series of proposals that address what some
which limited their efforts. When fiber and DSL advocates perceive as an absence of competition
were relieved of their unbundling obligation in in the broadband industry. Most important
the early 2000s, however, capital poured in and among these are the imposition of “net neutrality”
these services flourished as fixed-broadband rules that would compel all Internet traffic
competitors to cable. In fact, that competition to travel at the same speed and on the same
drew a competitive response from cable, in terms; restrictions on usage-based pricing or
turn leading to a virtuous cycle of improvement other broadband business models, including
and enhancement resulting in the United prohibitions on creating a “two-sided” market in
States ascending to the upper reaches of the which Internet-based business might pay to reach
International broadband rankings. network users (much as advertisers pay to reach
newspaper readers); mandatory interconnection
This background sheds important light on current rules that would empower regulators to dictate
calls to impose “new” regulations on broadband prices or procedures for the exchange of data
either through “network neutrality” rules or by among networks in the Internet’s labyrinth; limits
reclassifying it as a “telecommunications service” on the participation of selected firms in auctions
subject to common carrier obligations. While of electromagnetic spectrum; and facilities
advocates suggest otherwise, these proposals are “unbundling,” which would require providers of
clearly not new, but would represent a return Internet infrastructure to make portions of their
to the dated—and in the view of this paper physical networks available to all competitors at
failed—approach that the bipartisan 1996 Act was prices set or approved by the government.
designed to sweep away. Most of these proposals
for network micromanagement, forced sharing Some advocates claim that these “new” ideas are
of investments, and government influence on needed to address new problems; they contend
pricing have been associated with low investment that Internet service is not provided competitively
and innovation. These rules may have made sense or that it is too important to leave unregulated.
when the problem was how to protect consumers In a separate paper, we will argue that there is
in the days of the sanctioned Ma Bell monopoly, no “competitiveness” problem in the provision
but the business and consumer landscape is of broadband when conventional yardsticks such
dramatically different today in almost every as investment, innovation, or prices and profits
regard. are considered.1 But regardless of the merits of
the assertion that the provision of broadband is
2Policy Memo Progressive Policy Institute
uncompetitive, the regulatory proposals that make Commitment,” under which it would allow non-Bell
up this debate are not, in fact, new ideas. Instead, local companies to connect to its interstate (long
most of the proposals for Internet regulation are distance) system. It also made other concessions
the regulatory tools government applied to the (including divesting Western Union, the second “T”
telephone system during its period as a regulated, in its name) in return for a government sanctioned
government-sanctioned monopoly decades ago. monopoly.
The deal hardly held AT&T back. The behemoth
Most of the proposals for still used access to the long distance market as a
Internet regulation are way to disadvantage local competitors. Regulation
the regulatory tools of its acquisitions was lax. And, meanwhile, in a
different realm, radio was burgeoning. All of this
government applied to combined to create pressure for a new federal
the telephone system framework towards telephone and radio, which
during its period as a led to the Communications Act of 1934 (the “1934
Act”).
regulated, government-
sanctioned monopoly The 1934 Act established a framework for telephone
regulation that would last for half a century.
decades ago. AT&T’s interstate long-distance lines would be
subject to federal regulation, and intrastate lines
But the circumstances then were very different would be regulated by the states. Interconnection
from those we face today. For that reason, a among these systems was mandatory and regulated,
review of the history of Internet policy, from the and a system of settlements was created to allocate
formation and break-up of the Bell system to revenues and costs between and within the long-
the current-day court cases that address many distance company and local operating companies
of the underlying questions regarding the legal and to balance accounts. The 1934 Act created
framework for regulation, is in order. Where the Federal Communications Commission (FCC)
were these policy proposals first raised, and in to carry out the federal regulatory role in both
what context? And what can be learned from our interstate telephony and radio.
experience with them? Those are the questions
this paper will address. This system survived for decades, but was
ultimately undone by technological change,
The next section provides a brief history of U.S. beginning in the long distance market. Microwave
regulatory policy towards the Internet from technology created new competitors in the long-
the perspective of telecommunications. 2 That is distance market, led by MCI. The long-distance
followed by an attempt to identify the roots of market was particularly ripe for picking, as
leading contemporary policy proposals in that regulators generally allowed inflated long-distance
history and to apply the lessons learned from this pricing to cross-subsidize universal service,
review. emergency response, and other local services,
especially residential phone service. AT&T
Telecomm Roots fought these competitors in court and through
By the 1910s, AT&T had a commanding discrimination in its practices (for example,
position in the U.S. long-distance telephone requiring competitor long-distance companies to
market, and it used that position to begin use a “dial-in” number to get access), but ultimately,
acquiring local companies, often by denying the pressure of technological progress became too
others interconnection. In 1913, facing a federal great. In 1982, AT&T and the Justice Department
antitrust suit, AT&T entered into the “Kingsbury entered into an antitrust consent decree—the
3Policy Memo Progressive Policy Institute
“Modification of Final Judgment” (“MFJ”). While did not appear until the 1990s) contributed to a
the name may sound like a panel on the ceiling backlash that led to the Cable Television Consumer
of the Sistine Chapel, it actually restructured the Protection and Competition Act (“Cable Act”) in
telephone market. 1992, which gave the FCC authority to regulate
cable prices and mandated that content developed
and owned by the cable companies (e.g., HBO at
A bipartisan consensus that time) be made available to competitors. The
gradually emerged in FCC soon imposed price rollbacks on cable services
using its new authority, with disastrous results
response to these for investment in both the cable system’s physical
developments that steps networks (which limited their ability to emerge as
were needed to promote an important source of telephone competition) and
cable programming services (which, confusingly, are
competition in all of also commonly referred to as “networks”).
these arenas.
Like the 1934 Act, the MFJ and the Cable Act
“worked” so long as their underlying premises
The MFJ’s major provisions were, essentially, regarding technology and market structure did not
three-fold. First, AT&T would divest itself of local change. But the prospect of greater competition
affiliates and become a long distance company in both long-distance and local telephony was
(inter-exchange carrier) in a competitive market. clear—long-distance rates were dropping and long-
Second, the local telephone companies would be distance providers were beginning to bypass local
organized into seven regional competitors that loops in some situations. There was already some
would be barred from providing long distance local competition for business communications in
and information services, and whose local services local phone markets. Meanwhile, Direct Broadcast
would continue to be regulated, predominantly Satellite (“DBS”) entered the market and cable
by the states. And, third, the local telephone companies were experimenting with what then
companies were barred from manufacturing both seemed to be futuristic systems involving hundreds
telecommunications network equipment and of channels and even “high-speed data,” even
telephones and other so-called “customer premises as cable investment slowed in response to price
equipment,” buttressing the FCC’s earlier decision regulation.
to end the Bell System’s monopoly over this
hardware. A bipartisan consensus gradually emerged in
response to these developments that steps were
The regulation of cable proceeded on a parallel needed to promote competition in all of these
track. Today we think of telecom and cable arenas—local telephony, long distance, cable,
companies as being in the same business. But their and even the prospect of “video dial tone,” that
roots were obviously different. Cable was subject is, television delivered by the phone system. This
to local regulation, but the profusion of inefficient, consensus culminated in the Telecommunications
disparate regulatory standards and procedures led Act of 1996. That Act not only addressed that
government and industry alike to embrace the 1984 objective, but—to some extent unwittingly—set the
Cable Communications Policy Act, which imposed stage for the broadband Internet of today.
some discipline on the process, gave the companies
more latitude to price, and fed a cable investment The Telecommunications Act of 1996
boom in that decade and afterwards. The Clinton Administration brought with it a very
specific view of the future of telecommunications.
But the increasing prices of cable services and It saw the potential for an explosion in
then-minimal competition (satellite competitors “information services” and believed strongly
4Policy Memo Progressive Policy Institute
that relying on private investment and markets But, nonetheless, the 1996 Act set the framework
would be the best route to promoting innovation, within which the high-speed Internet arose and
raising investment capital, and managing the telephone, cable, and the Internet converged once
uncertainties about the shape these future services technological change bridged the divisions among
would take. them. The Act did so through two, interrelated
features. First, the Act embraced and codified the
It applied this perspective widely. For example, it distinction between telecommunications services and
argued in international fora that the Internet did information services. The former was essentially
not belong in the province of the International the telephone system that had evolved through
Telecommunications Union, since it was different the Kingsbury commitment, the 1934 Act, and
than standard telephony. It made sure that the the MFJ. The latter, “information services,” would
governance structure of the Internet remained soon include the cable and broadband worlds, but
in private hands—those of the user community— at that moment mostly consisted of the private
rather than being moved to government decision data networks used by larger companies to link
makers. It took steps to facilitate Internet computers, faxes, and other gear, and the then-
commercialization. And, with the Congress’ fledgling world of dial-up services like Compuserve
cooperation, the Omnibus Budget Reconciliation and America Online. Second, the 1996 Act treated
Act of 1993 preempted state and local regulation those different classes of service very differently.
of entry by and rates for mobile telephone services, Information services were by law excluded from
even though these were not yet regarded as direct traditional common carrier regulation, while
competitors to other pieces of the telephone traditional telecommunications continued under
industry, let alone what we now think of as the this regulatory frame. Cable systems received some
broadband Internet. And the deregulation of other limited regulatory relief, such as a sunset on
mobile telephony was accompanied by public some pricing regulations by 1999 (although basic
auctions of spectrum to support it (championed rates remain regulated today unless the FCC finds
and overseen by then-FCC Chairman Reed Hundt), that adequate competition exists in a given market).
the first of which took place a year later and which At the same time, the Baby Bells were allowed
resulted in increasing the number of competing entry into the cable business, from which they had
wireless companies. The burgeoning success previously been barred. Yet broader deregulation
of mobile telephony and, subsequently, mobile of telecommunications, while an aspiration, would
broadband has its roots in this decision. await the emergence of expanded competition.
But the most important manifestation of the
Clinton Administration’s perspective was the The 1996 Act was the
Telecommunications Act of 1996 (“the 1996 Act” or watershed event that marked
“the Act”). The 1996 Act was the watershed event
that marked the end of the telephone age and the
the end of the telephone age
beginning of the Internet age in the public policy and the beginning of the
realm. Internet age in the public
Today, we regard the convergence of telephones, policy realm.
television, and the Internet as a fact of life. In
1996, it was considered a futuristic proposition.
The purpose of the 1996 Act was both to promote The Act attempted to create competition in local
the convergence of these different delivery telephone markets in three ways still relevant
modes through inter-modal competition—and to today. First, it prohibited states from sanctioning
foster competition within each of its individual any local monopoly by the “Baby Bells.” Second,
component sectors (intra-modal competition). it required the Baby Bells to interconnect with
5Policy Memo Progressive Policy Institute
emerging competitors on state supervised rates, The first commercial point-and-click browser was
terms, and conditions, and created telephone developed by Netscape, and public awareness of
number “portability,” allowing users to keep the Internet boomed. Dial-up services such as
their number if they switched providers in order AOL and Compuserve went from being “walled
to jumpstart local phone competition (a critical gardens” of content to gateways to the Internet.
requirement both to get competition started and The beginnings of a race by investors to fund the
maintain it in the long run). Third, and most digital Internet and the enterprises that would use
controversially, it established that emerging local it began, setting in motion the dot.com bubble
competitors to the Baby Bells could get wholesale of the late 1990s. The 1996 Act was signed on
connections on the Bells’ existing local phone February 8 of that year, and only 10 months later,
networks and then resell that capacity in the retail Fed Chairman Alan Greenspan soliloquized over
market—a procedure known as “unbundling” “irrational exuberance” in the stock market.
(since it required the phone companies to separate,
or “unbundle,” the capacity on their systems that
supported voice calling and sell it at a below- The idea of an
retail rate). Unbundling spawned a new class of “information
“Competitive Local Exchange Carriers” (CLECs) superhighway” had
who availed themselves of this privilege and, to a
great extent, became the lynchpin of the debate caught on, although it
over implementation and enforcement of the Act. was unclear exactly what
As mentioned, the 1996 Act didn’t expressly
it would be.
compel the convergence of phones, cable, satellites,
mobile phones, and the broadband Internet.
But, at the same time, the sense that we faced So, while the 1996 Act addressed the specifics
a dramatically different future was in the air. of both intra-modal and inter-modal competition
The idea of an “information superhighway” had for traditional telephone services, it also pointed
caught on, although it was unclear exactly what towards a radically different future that it could
it would be. The Clinton Administration, and not define but nonetheless sensed. In 1996, the
Vice President Al Gore and Commerce Secretary cable and telephone worlds were distinct, and
Ron Brown in particular, were enthusiasts for the reciprocal interest in competing was guarded.
promise of such innovation—the Administration While some cable companies showed interest
was busy at work on various policies to facilitate in telephony, the cable industry as a whole did
the Internet’s commercial development. And not race into it, although some began offering
important developments were setting the stage voice services after the Act was passed and
even as the 1996 Act was being debated and others contemplated investments in circuit-
written. switched phone service. Phone companies had
experimented with “video dial-tone” trials but
As the 1996 Act was being debated, important there was no evidence that there would be
technological developments were in motion. The consistent and adequate consumer demand
switch from analog transmission of signals (in justifying a permanent commitment. High-speed
which a signal such as your voice is sent as a broadband (at least by today’s standards) did not
continuous and uninterrupted stream of waves) yet exist in the commercial market, much less the
to digital communications (in which a signal residential market. But the Act’s intuition was
is repeatedly sampled at very high speeds and that, if the markets for the two types of services
converted into 0s and 1s) was proceeding rapidly, were competitive, and if the two systems entered
driven by cost and efficiency concerns as well as into facilities-based competition—meaning wholly
the potential product offerings it made possible. separate systems would connect the household to
6Policy Memo Progressive Policy Institute
services—long-term inter-modal competition could
be strengthened at the same time. As baseball
executive and savant Branch Rickey is said to have
remarked, “Luck is the residue of design.” Or, as
Louis Pasteur said, “Chance favors the prepared
mind.”
At the same time, common carrier telephone
regulation remained in place—and in some
ways was made stronger by the 1996 Act. The
unbundling provision—the requirement that the
historical local phone companies make their parts
of their networks available to local competitors
at government set prices—was controversial and
proved difficult to implement. The problem was
this: the Act was now repealing the incumbent
phone companies’ life-long monopoly franchise,
and theirs was the only telephone infrastructure
in place. The idea that cable and wireless would
supplant them was not yet popular or substantiated
by experience. So the Act included the unbundling
requirement in order to rein in the local phone wholesale price the FCC and states established for
companies’ (presumably) temporary monopoly access to the phone companies’ loops, therefore,
power over local networks and to assist the was well below the actual historical cost structure
interexchange carriers like AT&T and MCI that of the incumbents who, predictably, resisted
lacked local network facilities but who faced the strenuously.
prospect of competition from the Bells in long
distance. And so, the 1996 Act left behind a trail of
controversies that have made up most of the
The pricing formula the FCC established telecommunications policy agenda since then.
to implement unbundling became a major First, where is the line to be drawn between
issue and influence on the development of information services and telecommunications,
telecommunications. As opposed to using prices and would Internet services continue to be
based on actual historical or embedded costs, past considered deregulated information services
depreciation patterns, and the like, it chose to or regulated common carrier services? Second,
use a forward-looking method based on what a where—if at all—should “unbundling” and sharing
theoretical future provider would charge, a provider of facilities be required? Third, when would we
that had built the most efficient contemporary decide that competition had developed to the
networks using the best available technology. This point that market forces could be relied upon to
standard was known as (yet another oppressive guide it, in lieu of the public utility perspective
acronym) TELRIC—total element long-run behind these regulations, and the ultimate goal
incremental cost. The problem was that TELRIC (as expressed in the preamble of the 1996 Act) of
was about what a prospective, efficient, new a “pro-competitive, deregulatory national policy
competitor would experience, which was far from framework” achieved? These questions defined the
the actual situation of the incumbent telephone broadband policy agenda for much of the coming
companies, who had big, expensive legacy systems decade.
left over from their previous life as heavily
regulated entities. The long-run, future-oriented
7Policy Memo Progressive Policy Institute
The World According to Kennard because the 1996 Act, in its focu-s on competition
“I want to create an oasis from regulation in the within telephone and cable silos, created two
broadband world, so that any company, using different playing fields for the two technologies.
any technology, will have incentives to deploy Cable systems were heading away from the most
broadband in an unregulated or significantly onerous elements of regulation of their business,
deregulated environment. And that does not and they were investing heavily. They upgraded
mean just cable companies. We must have their networks to handle digital signals after the
fast and ubiquitous deployment of broadband 1996 Act was made law, and their systems, where
services and that will only happen if every available, provided a very high quality of service
sector of the industry has incentives to provide to residential users. By the time Kennard spoke in
it: wireline, wireless and cable.” 1999, the cable companies were the cutting edge of
providing broadband, deploying many of the first
Remarks of William E. Kennard before the United high-speed Internet access services in the nation.
States Telecom Association Annual Convention,
October 18, 1999 The response to the cable-based broadband
offerings by the telephone systems was the more
FCC Chairman Bill Kennard’s statement, made vigorous deployment of DSL (Digital Subscriber
three years after the 1996 Act, was both a Line), a technology that allowed digital data
summary of what had happened since the 1996 Act services to be provided on the same copper wire
and a statement of what was expected to happen as voice by using a higher frequency along the line.
soon thereafter. Phone companies began introducing DSL by the
end of the decade, driven by consumer demands
Chairman Kennard’s vision of the long-term and in direct response to cable’s Internet offerings,
future of the Internet, once seen as an over-the- but they generally lagged behind their cable
horizon issue, was now explicitly one of facilities- competitors.
based, inter-modal competition, and the center of
that competition was no longer separate markets The slow response by phone companies to the new
for broadband and telephone (and potentially interest in the high-speed Internet was probably
video), but their convergence. And it was a also driven by the imbalances found in the 1996
deregulated future—an “oasis” from regulation Act. A cable company, as a provider of information
would be created in order to give “every sector of services under the 1996 Act, had something closer
the industry” the incentives to invest in it. to the customary right to deploy its investment as it
saw fit, although it still had a variety of regulatory
mandates to fulfill. But the 1996 Act limited the
An “oasis” from incentives of telephone companies to invest in
regulation would be Internet improvements by imposing regulatory
created in order to give “unbundling requirements,” which required
telephone companies to share their copper phone
“every sector of the lines at the TELRIC price standard. In essence,
industry” the incentives anyone who wanted to pursue it could lease access
to invest in it. from the phone company and enter the business in
competition with the phone company at wholesale
prices, whether used for voice communication or
broadband connection service. This put the phone
But perhaps the most telling part of this quote companies in a Catch-22. They had to sell the
is that the deployment of broadband “does not most important component of DSL service—the
mean just cable companies.” That reflected both network that conveys it—to their competitors. But
reality and Kennard’s vision. It reflected reality if they made the significant investments needed
8Policy Memo Progressive Policy Institute
to offer a better product—for example, by laying induced DSL competitors, who had built
optical fiber for the “last mile” from the network broadband businesses based on unbundled
to the home—they could find themselves forced wholesale access to the Baby Bell’s physical
to resell that improved capacity to competitors as networks. While still a competitor in today’s
well. As a result, they had little incentive to make market, Earthlink’s revenues peaked in 2003.
new investments, and were being outcompeted Covad was valued at $10 billion in 1999 and close
due to regulation of the old ones. They were to nothing a few years later. These meteoric rises
frozen in place, (a situation that now confronts the and precipitous falls reflected the nature of these
European Union, which uses a similar system and companies—they made no investments in their
is falling behind the United States). own infrastructure, which limited their ability to
innovate, and their profitability was a product of
The freezing of the phone companies in this regulatory privilege, not their own inherent ability
fashion slowed the nation’s overall rate of to create value.
investment in high-speed Internet via fiber and
DSL. Critics of the industry often seize upon By the end of the 1990’s, these dynamics
this performance and use it as an argument were coming to dominate the debate. Cable
to impose yet-stricter regulation of Internet was winning the race to provide high-speed
providers. But, as described below, once the FCC broadband, and telephone competitors were at a
eliminated unbundling requirements for new disadvantage due to the unbundling requirement.
fiber networks in 2003, and the courts set aside The vision laid out by Chairman Kennard in
line-sharing unbundling more generally in 2004, the above quote was widely understood and had
telco investment in fiber, either directly to the bipartisan support—in that year, he went further,
home (Verizon) or to neighborhood nodes (AT&T), and laid out a visionary plan for the FCC’s role
began quickly and earnestly. Unconstrained by in a competitive, post-regulatory environment. 3
mandatory unbundling, cable companies had But the vision still had to be reconciled with the
already responded with new versions of their questions left behind by the 1996 Act—where was
DOCSIS high-speed data standard that met or the line between an information service and a
exceeded the speeds of their rivals who, now telecommunications service to be drawn, and was
similarly treated, responded in turn. As a result, such a line an eternal fact of life, or a creature of
the United States, driven by new competition the technologies available at the time? Was the
between the telcos, cable companies, and wireless transitional device of “unbundling” really just a
providers, now lags only Japan among the transition? To whom would it apply, and when
G-7 nations, and only highly urbanized Japan might it end? The next decade would answer many
and Korea (nations with very high population of these questions.
densities, a key cost consideration in providing
wired service) in connection speeds. So industry The Rise of Information Services
critics found themselves in the awkward position As technology progressed on many fronts, the
of advocating unbundling as the policy needed convergence of the many sources of broadband
to improve U.S. broadband’s performance, even connectivity began in earnest, and true
though that specific policy was directly responsible competition was the result. While this was an
for the lag in U.S. high-speed broadband adoption. unambiguously good thing, it left an important
The industry sprang forward, both in absolute issue unresolved—was broadband access in
speed and in international rankings, only once all cases an “information service” or was it
the policies the industry’s critics advocated were a “telecommunications service” that should be
abandoned. subjected to the same type of common carriage
utility style regulation that applied to voice
The inroads made by cable during this period also communications?
hurt both the telcos and the telcos’ regulation-
9Policy Memo Progressive Policy Institute
While the original intent of the Clinton that would make it subject to common carrier
Administration and the Congress seemed regulation.
clear, it was not until after a series of regulatory
pronouncements and court decrees that common Then on August 21, 2003, the FCC released
carriage was taken off the table for all services a “triennial review order” that eliminated the
except local phone networks.4 And, through unbundling requirement for fiber-to-the-home
these decisions, the regulators and courts made broadband capacity. (It also eliminated the
important statements about “information services” unbundling requirement for “hybrid” fiber and
and “telecommunication services,” and the copper loops, but allowed that states may find
networks over which they were provided. it necessary to re-impose those measures when
some local competitors would be “impaired” by
disallowing them wholesale access.) Verizon almost
The FCC under Chairman immediately began formulating and implementing
plans to deploy fiber into neighborhoods and
Michael Powell ruled that ultimately, to residential premises now that the
Internet access provided by disincentive to do so had been eliminated.
cable companies should be The decision to liberate fiber was not universally
classified as an “information acclaimed. One FCC Commissioner argued
service” and not a that “today’s decision chokes off competition in
broadband. Consumers, innovation, entrepreneurs
“telecommunications and the Internet itself are going to suffer. . . . This
service”. is not a brave new world of broadband, but simply
the old system of local monopoly dressed up in
a digital cloak.”5 In retrospect, it is difficult to
In 2002, after a regulatory process that spanned defend that prediction. The introduction of fiber-
two Administrations of both parties, the FCC to-the-home was both spurred by cable’s entry into
under Chairman Michael Powell ruled that broadband and, in turn, produced a competitive
Internet access provided by cable companies response from the cable industry that has
should be classified as an “information service” improved the U.S. absolute and relative broadband
and not a “telecommunications service,” performance dramatically, demonstrating the value
removing the specter of wholesale imposition of of facilities-based competition. Thus, deregulation of
a wide range of common carrier requirements, “telco” broadband actually spurred investment by
including unbundling. Opponents had claimed cable, telco, and wireless competitors, a cycle that
that, even though cable modem service brought continues today, as Advanced DSL and DOCSIS
consumers the entirety of the Internet (and that 3.1 are readied for market, and 4G LTE becomes
was why consumers purchased the service) the ubiquitous. It is hard to imagine that we would
underlying transmission was itself the sale of have been better off if continued unbundling
telecommunications to the public and thus should requirements had prohibited fiber deployment,
be classified as telecommunications (i.e. common much as it would be hard to argue that we would
carrier) services. But, in a March 14, 2002, have been better off if providers of cable modems
Declaratory Ruling, Chairman Powell announced were forced to open their facilities to competitors.
that the FCC had “settled a debate over the
regulatory classification of cable modem service Over time, the Courts provided clarity on the
and launched a proceeding to examine the proper nature of the mandates applied to different groups
regulatory treatment of this service” and that cable of providers. For example, the FCC’s Triennial
modem service did not contain a separate and Review Order that eliminated unbundling for
distinct “telecommunications service” offering fiber loops did not provide the same treatment
10Policy Memo Progressive Policy Institute
for hybrid loops of fiber and copper under some of the difference between telecommunications
circumstances. But when industry groups appealed and information networks discussed above have
that part of the order, the U.S. Court of Appeals centered on their essential character. But as the
for the District of Columbia Circuit in March 2004, last decade progressed, the debate soon moved
essentially rescinded any unbundling requirement on to their engineering and logistical nature.
save for a minimal level of access—64 kbps, In particular, two policy proposals moved to
enough for voice service, reflecting the original the fore—“net neutrality” and the regulation of
intent (to preserve telecommunications services) network interconnection—each of which seeks
of the 1996 Act. And in June 2005, the Supreme to have broadband networks behave like their
Court ruled in what is known as the Brand X case.6 telephone antecedents. These have become
In that case, a small Internet service provider in perhaps the most loudly debated, if not most
Santa Monica, California, argued that the cable important, aspect of policy toward the Internet
modem ruling of 2002 was in error, that the data today.
communication portion of a cable modem service
was a telecommunications service, and that it was “Neutrality” first: The telephone system of a
therefore subject to common carrier regulations generation ago was “dumb”—it did little more than
requiring (among other things) cable companies to set up an electrical circuit between a calling
to unbundle it for competitors. But the Court party and a called party. In the analog world, that
ruled that the FCC’s determination that cable voice signal was a continuous wave carried without
broadband was an “information service” was interruption from one destination to another—that
reasonable and could stand. was the only way the system could work. If the
system was overloaded, the caller got a busy signal
After Brand X (and follow on proceedings at and came back later.
the FCC), the basic questions regarding the
application of the 1996 Act structure to emerging By contrast, under the protocols that now govern
Internet technologies and innovations appeared not just voice transmission but all data, image,
resolved (although controversies remained video, or other streams on the digital Internet,
as the FCC worked through the implications all messages are broken down into “packets” that
of the decision for DSL, wireless broadband, find their way across the Internet individually and
and other services). The Courts and the FCC are reassembled when they arrive, a technology
had converged around one view—that simply that lies behind the increases in speed, network
because an “information service” contained a utilization, quality, and declines in cost of the
“telecommunications” component that did not past decades. That means that networks can be
make it a “telecommunications service” subject managed to optimize their performance—they’re
to public utility common carrier regulation. This not “dumb,” as was the old phone system.
was the logical interpretation of the 1996 Act’s
provisions in light of dramatic technological This difference emerged as a policy issue in
change, which was ratified immediately by the mid-2000s. In 2005, for example, the
capital markets that poured vast investment into FCC fined Madison River, a North Carolina
companies and technologies when it became clear telecommunications company, for blocking
the common carriage regime (and, therefore, the Vonage’s VoIP traffic, which potentially competed
possibility of unbundling) would not apply. In this with Madison River’s own telephone service.
context, at least, the policy intents of the 1996 Act The question of limiting certain types of traffic
and of Kennard’s 1999 vision had finally been became more nuanced in 2007, when Comcast
achieved. began to manage traffic that used BitTorrent, a
program used for very high volume applications
Net Neutrality and Network Management like peer-sharing music, video, or other large
The various regulatory and legal considerations files. To some, the decisions to limit BitTorrent
11
11Policy Memo Progressive Policy Institute
during periods of Internet congestion could be ignores the reality that different Internet traffic
analogized to a grocery store deciding how many can have different needs for speed and reliability.
registers to open and how many lanes should be Because the broadband network has intelligence,
devoted to those customers with a limited number it could readily offer different levels of service,
items. But critics raised the possibility of Internet allowing some content to move more rapidly (for
providers editorially managing the traffic on their instance, by keeping their packets together instead
system—deciding what traffic would move and at of distributing them—thus eliminating “buffering”
what speed based on what the providers “liked” as they are reassembled). This would be one way
or “didn’t like.” Perhaps this would be editorial to resolve congestion, and the ability to use a
control, perhaps they would quash traffic that “premium” service would greatly assist innovations
competed with their own (for example, blocking that require such an unbuffered connection,
Netflix because it potentially competes with a such as remote medicine, distance learning,
provider’s video-on-demand). These advocates entertainment and gaming, and the like.
ultimately petitioned the FCC to prohibit the
practice as applying to BitTorrent, and the Net neutrality opponents argue that allowing
episode became an emblem for the policy of “net content to pay for the higher quality of their
neutrality” (which postulates that all traffic should signal (much as we allow households to pay for the
move across the Internet under identical terms higher speed of their connection) could reduce
and conditions, much as telephone calls did under the share of network costs borne by end users. An
the regulated, analog voice system). In essence, analogy can be made to a newspaper—it charges
neutrality advocates wanted the broadband advertisers to reach its readers, and readers to
network to act the way the old phone system see its advertisements—it is a “two-sided market.”
did. Moreover, they argued that the Internet If a newspaper were prohibited from charging
“always worked that way,” and that this equality of advertisers for space, the cost of the newspaper
treatment of all data was essential to its character. to readers would be much higher. Not charging
content (websites) for premium access, therefore,
potentially increases costs to users, who end
The idea that all traffic up subsidizing content, including content they
must be treated equally may not use and that others in the market would
sounds democratic, but readily support.
can be costly and This debate over neutrality rages today. The
inefficient in practice, and purpose of this paper is not to resolve it, but to
ignores the reality that place it in historical context.
different Internet traffic The debate first flickered to life in D.C. policy
can have different needs circles when Chairman Powell spoke on
“Preserving Internet Freedom” at the February
for speed and reliability. 2004 Silicon Flatirons conference. The following
year, the issue was joined in earnest when the
FCC issued its “Internet Policy Statement,” an
To neutrality’s detractors, these arguments missed attempt to identify general principles that might
the point. The Internet that “always worked that guide the management of network traffic. That
way” was one that delivered files and mail to statement said that consumers were entitled to:
users, not data-intense video files and other large access the lawful Internet content of their choice;
claimants to bandwidth. Moreover, the idea that all run applications and services of their choice
traffic must be treated equally sounds democratic, subject to the needs of law enforcement; connect
but can be costly and inefficient in practice, and to any device that does not harm the network;
12Policy Memo Progressive Policy Institute
and a competitive market for all components of had to be mandatory because otherwise any of the
the Internet “package”—connectivity, devices, system’s sanctioned monopolists (in either long
services, applications, and the like. Although the distance or local service) could try to jack up the
Commission did not adopt rules in this regard, it price of interconnection to the other by holding
said it would incorporate those principles into its the system hostage, and all heck would break lose.
ongoing policymaking activities.
But the Internet works differently. Websites
But at the same time, it recognized that those generally take their content (either on their own
principles were subject to “reasonable network or through a contacted service provider) to one
management,” which left situations like the of many “backbone” networks that make up
Comcast/BitTorrent instance in a regulatory the Internet, which in turn take it to the local
grey area. The FCC ordered Comcast to make networks in your neighborhood. There are many
its network management practices transparent. of these backbone providers—not just ISPs, but
But what gave the FCC the right to regulate the also such more specialized companies as Cogent,
way information services were managed? If a Tata, and others—and they move data across
telephone company in a prior age had created the network to minimize cost and maximize
a system that allowed some users to bypass a speed and efficiency through a flexible system of
busy signal, the FCC would have prohibited it, arrangements. If these backbone providers billed
as part of its mandate to regulate a sanctioned each other every time a message jumped from
monopoly. But broadband (an information, one of their lines to the others, they’d go nuts
not telecommunications, service) exists in a processing the transactions. So, instead, when the
competitive environment funded by investors. two parties are roughly the same size in terms of
What gave the FCC the authority to regulate volume of data transferred, they set up a peering
network management practices in that world the relationship, which says that they will trade data
way it did in the first? without billing so long as the volume moving both
ways is “roughly” in balance. If their traffic falls
Comcast took the FCC to court over the BitTorrent out of balance, they settle up and figure out how
order and, in 2010, the U.S. Court of Appeals for to manage the imbalance. When two networks’
the D.C. Circuit found that the FCC had failed to traffic exchanges are dramatically different in
show that its decision was reasonably related to size, other “settlement based” or commercial
its statutory authority. Taking this authority unto arrangements allow this exchange to occur.
itself, the Court found, would “virtually free the
Commission from its congressional tether,” giving “Peering” and other arrangements, therefore, are
the FCC the ability to impose regulations on the Internet’s effective free-market substitute
Internet service providers that were not based on for mandatory and regulated interconnection, a
Congress’ expressed intent. A second and more system that makes the competitive backbone
basic legal challenge to the FCC’s ability to impose “market” work just as the old system made the
neutrality on the Internet will be discussed below. prior-day, regulated monopolies work. The
system has been tested, several times, most
A second regulatory proposal would recreate publicly in an instance involving Level 3 and
the old phone system’s practices regarding Comcast. Level 3 and Comcast had a settlement-
“interconnection.” The old phone system, as free peering agreement, one that required that
mentioned above, had both long distance and traffic exchanges be roughly in balance, per the
local carriers. Regulation required all of them to companies’ respective published peering policies.
interconnect at a specified “price.” “Price” is set in Then Level 3 entered into an arrangement to carry
quotes because what was really being set was the huge amounts of Netflix’s movies on its network,
way in which revenues would be divided among which resulted in the balance of traffic between
the system’s participants. And interconnection Level 3 and Comcast falling far out of balance.
13Policy Memo Progressive Policy Institute
Comcast asked to move to “settlement based” prohibit differentiated service (so long, of course,
peering but Level 3 refused to pay and escalated as it didn’t violate antitrust or other consumer
its argument to the FCC, insisting that Comcast’s protection statutes), or regulate interconnection,
demand that they renegotiate their peering was a because of the difference between information and
violation of an “open” Internet and the FCC’s oft- telecommunications services, the same distinction
stated principle of “net neutrality.” FCC Chairman the FCC cited when freeing the latter from
Julius Genachowski, in remarks before Congress, common carriage requirements.
leaned toward Comcast’s view, arguing that
peering disputes were private business matters, The Court’s decision in this case was delivered
and expressed the hope that companies like Level in January 2014. While it acknowledged the
3 and Comcast could work out their differences FCC’s role in promoting the Internet, it found
as was routinely done in the marketplace. (The that the FCC, having classified broadband ISPs
companies did in fact work out an agreement, as information service providers, could not
without regulatory intervention.) impose common carrier-type regulations on
them. In response, many advocates for neutrality
A similar dispute is now underway with Cogent— and similar regulation now suggest that the
yet another conveyor of Netflix content—and FCC identify (or “reclassify”) the Internet as
Verizon. (Note that video plays a role in both these a telecommunications service rather than
examples.) And, again, advocates for regulating an information service, thereby undoing the
network interconnections see this dispute over distinction first made in the law in the 1996 Act,
traffic exchange among networks—a dispute and undoing the Clinton Administration’s guiding
resolved by regulation under the rules of the old intent.
phone system—as an example of the need for
regulation of the new broadband system, even What Are the Lessons?
though the vast bulk of Internet traffic moves Different analysts will take different lessons from
through these market-based arrangements without this history. This review sees three of primary
incident. importance. They are:
Thus, the debate over regulation of the Internet • information services and telecommunications
has moved from the issue of common carriage services really are different;
to the issue of network management. But, • investment and capital flow to where regulation
paradoxically, the resolution of the second (or the absence thereof) encourages them to
question could lead us back to the first. In flow; and
December 2010, the FCC issued its “Open Internet • technology, business models, and consumer
Order,” which prohibits Internet service providers behaviors change and, as they change, the
from “discriminating” against any legal content meaning and effect of different regulatory
among other requirements, subject to reasonable proposals change as well.
network management requirements. This is often
assumed to prohibit ISPs from offering “tiered” The rest of this section examines these three
services to Internet content providers, although propositions.
it may be argued that allowing content providers
to pick a service tier at posted prices is no more The 1996 Act codified the distinction between
discriminatory than letting consumers choose information services and telecommunications
among “good,” “better,” and “best” from Sears. services, and expressly limited common carrier
regulation to telecommunications. The Internet
Verizon, in response, appealed the Open Internet has flourished as this distinction was put into
Order in the courts, claiming that the FCC lacked practice and, critically, common carriage status
the authority to impose the neutrality requirement, and unbundling requirements were either lifted
14Policy Memo Progressive Policy Institute
or were never placed on the various information would have been outrageous. Imagine, for instance,
service providers that offer high-speed broadband. that we applied unbundling to peanut butter,
and Peter Pan had the legal right to use Skippy’s
manufacturing facilities at a price determined
The 1996 Act codified by what Peter Pan’s processing costs would be if
they had built a new, state-of-the-art plant (which
the distinction between they did not and had no intention to do). That
information services and is exactly what unbundling does. The 1996 Act,
therefore, imposed common carriage in a narrow
telecommunications
area to correct for a historical fact, but it spared
services, and expressly new forms of innovation and investment from this
limited common carrier burden.
regulation to The differences between telecommunications
telecommunications. services and information services recognized by
the 1996 Act have been extended significantly
since then, in part because of the way the 1996 Act
One of the intentions of the 1996 Act was to treated them, and in part because of technological
preserve the commitment made to the public in progress. The old phone network addressed by the
the 1934 Act—that they would have access to local 1996 Act was built by sanctioned monopolies that
telephone service at affordable rates, including traded the market power the government ceded
emergency services such as 911. Cable was still to them for a regulated return and the ability to
subject to a variety of regulatory mandates—its invest in facilities with minimal risk. But Internet
basic tier was subject to price regulation, and it access has been provided by competing private
was still subject to certain carriage and tiering parties who have risked their own investments—
requirements—but the Act asserted a basic over a trillion dollars’ worth since the 1996 Act—
difference between telephony and cable television, without government guarantees. This extends
data communication, or other information the original basis for the distinction between
flows, as had past FCC regulatory practice and the two systems—information services were
the perspective of the Clinton Administration. financed by risk capital, in contrast to their legacy
The distinction made in the 1996 Act between telecommunications counterpart.
telecommunications and information services
reflected genuine and significant differences in The system of sanctioned monopolies also gave
the nature of the two services—differences in rise to mandatory interconnection and settlement
functionality, in engineering characteristics, in policy regarding shared revenue (for instance, the
their potential for innovation and improvement. division of dial tone revenues to local versus long
The differences and distinctions between the distance calling). The system needed mandatory
two made in the 1996 Act were not political or interconnection to work, and required a method
semantic, but real. for allocating revenues and costs among long
distance and local traffic (which essentially
The distinction between the two types of services determined what the price of that interconnection
was made so that there would be a guideline was) to determine profits as well as to subsidize
for determining where regulation and common many local services. The Internet, in contrast,
carriage status were needed. It was imposed on is a “network of networks” comprised of many
providers of telephone services because these had different companies’ facilities. As opposed to their
been local monopolies and, therefore, had the only regulated predecessors, these companies are in the
telephone infrastructure in place. Had this not business of interconnecting. Occasional cases such
been the case, the imposition of common carriage as Level 3 and Comcast, or Cogent and Verizon
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