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PART II: POLITICS

Shaping the Architecture of the U.S. Information and Communication Technology Architecture: A Political Economic Analysis1
Peter F. Cowhey UCSD, Graduate School of International Relations and Pacic Studies Jonathan D. Aronson Annenberg School for Communication and School of International Relations John Richards UCSD, Global Information Industry Center Abstract
How did political economy help shape the revolution in telecommunications and computer networking? We offer three arguments concerning the impact of political economy and policy on the architecture of the U.S. information and communication technology infrastructure. First, it tilted toward an architectural principle of modularity that inuenced the paths of both the telecom equipment, computer equipment and software, and computer networking markets. Second, it created multiple network infrastructures for telecommunications when other countries either tried to retain a monopoly infrastructure or limit the number of competitors. Third, it propelled a particular architecture for computing (intelligence at the edge of the network) and the full realization of the potential benets of the Internet. The particular policy mix for competition matters, and this policy mix reects fundamentals of political economy.
KEY WORDS: computing intelligence, decentralization, electoral institutions, federalism, technological trajectories

This article analyzes how policy and politics shaped the architecture of the global
information and communication technology infrastructure, the ICT infrastructure. This intersection of computing with the telecommunications network, which now is embodied in the Internet and the Web, changed dramatically from the mid-1950s to the end of 2000. The potential for a radical change in the ICT infrastructure grew from the capabilities in computing, electronic switching, and ber optics that sprang from the microelectronics revolution. The United States made the rst and most radical break with monopoly in telecommunications and led the revolution in computer networking. But political economy factors shaped the specic technology path for the market place. Two key questions are asked. First, why did the United States take the lead in redening market structure away from a telecom monopoly and toward competition based on a competitive long-distance infrastructure? Second, how did Americas particular policy mix inuence the architecture of the ICT infrastructure? These two questions share a common premisetechnological trajectories reect policy and market conditions.2 Specically, U.S. policy inuenced the trajectory in three ways. First, it tilted toward an architectural policy principle of modularity, whose implementing policy norms inuenced the paths of both the
Review of Policy Research, Volume 26, Numbers 12 (2009) 2009 by The Policy Studies Organization. All rights reserved.

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telecom equipment and computer networking markets.3 At an intuitive level, modularity works in the same way as Lego building blocks. Many pieces of different shapes can be mixed and matched to form different forms because they have standardized interfaces that allow them to interconnect.4 Second, when other countries tried to retain a monopoly infrastructure or to carefully limit the number of competitors, it created multiple network infrastructures for telecommunications. Third, U.S. policy enabled a specic computing architecture (intelligence at the edge of the network) and the realization of the potential benets of the Internet. The process involved much more than the United States embracing competition in networking traditional telecom and new information services. These questions frame the issue concerning the emergence of competition in the United States rather differently than most economic analyses. Most economists focus on the degree to which the United States shifted in the direction of ideal competitive markets. Seen this way, the U.S. policy shifts arguably had deep aws.5 But this is the wrong approach; it is too narrow. The remarkable part of the U.S. story was how its trailblazing move toward a certain type of competition set the stage for the successful emergence of the Internet and the Web.6 The reasons that the United States chose its particular policy mix are revealing lessons in how the contours of a countrys political architecture inuences its policy propensities. The policy predilections in turn inuence technology markets. From the Olympian heights of microeconomics, the blend of policies was imperfect, but that is not the key issue. This case study lays out the policy and technology developments that shaped the American ICT infrastructure. In the mid-1950s, the ICT infrastructure began to emerge from the joining of two distinct marketsa monopoly telecom marketplace (the old AT&T monopoly) and a distinct, concentrated computer and software industry centered on mainframes (dominated by IBM), and then minicomputers (such as DEC). During the 1960s and 1970s, the growth of computer networking and nascent competition in terminal equipment (whether a phone or a computer) tied to the telecom network created a new market for value-added information services that regulators permitted as a limited exception to the telecom monopoly.7 As data networking matured, an integrated ICT market gradually emerged. The tensions over the commercial model for the merging ICT infrastructure helped to drive the breakup of AT&T in 1984. Later, a competitive telecommunications market bolstered a new model of computing that relied on the personal computer tied to ofce and wide area networks. This model came to full blossom in the form of the Internet and the Web. It ultimately reestablished U.S. leadership in the global ICT industry that was then under serious challenge from Japan. We rely on a case study to show why the specic policy mix chosen for ICT conforms to a well-established framework for understanding American political economy. But it emphasizes the consequences of particular political and policy compromises for the performance and architecture of the ICT infrastructure. Political economy means that policy rarely emerges in a pristine textbook manner. The twists of policy compromise inuenced much of the architectural nuance of technological change.

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At the same time, note what is not claimed. Although this path of innovation ultimately paid high returns to the United States and refurbished its global competitive leadership, there is nothing in this study to determine which national political economic structure is best for innovation or economic performance.8 The rst part explains why the United States moved rst on competition. We argue that the answer is rooted in Americas political economy, but we diverge substantially from explanations that focus mainly on the role of American courts or on interest-group politics. We point to the consequences of American institutional structureespecially divided government, federalism, and winner-takes-all federal electionsinteracting with a particular constellation of interest-group coalitions (the corporate competition coalition). Our conclusion concerning the consequences of policy, discussed in the second and third part of the article, explains the specic impacts on the ICT infrastructure. To simplify the exposition, we concentrate on the political economy of the telecom side of the ICT infrastructure and its consequences for the architecture of the infrastructure. Major changes in the information technology industry are noted throughout the analysis without delving into the same level of detail. The Political Economy of the United States At the core of the argument concerning the political economy of markets are political institutions and their impact on the incentives and authority of elected politicians to shape marketplace outcomes to the advantage of specic sets of constituents. This section sketches the institutional argument with examples from the ICT eras policy in the United States. The second and third parts of the article expand on these illustrations. The U.S. political system has three features that are salient to the setting of ICT policythe division of powers, the majoritarian electoral system, and federalism.9 First, the division of powers in the U.S. government was designed to make it difcult to initiate major policy changes, but also difcult to rapidly undo major commitments. The division between the president and Congress (and the division between the two chambers of Congress, one based on population and the other based on equal representation for the individual states) creates many veto points during the decision process where an initiative can be stopped.10 This hampers the passage of major changes in laws that have sweeping geographic consequences and a wide range of winners and losers. Thus, only two comprehensive U.S. telecommunications laws passed during the twentieth century, the 1934 and 1996 congressional acts. These two Acts delegated to the Federal Communications Commission (FCC) much of the decision making concerning federal communications and computer networking policy. The FCC shares jurisdiction on competition policy with the Antitrust Division of the Department of Justice (which largely focuses on specic complaints concerning violations of competition laws).11 The inherent conict between the executive and legislative branches means that Congress is less willing to grant the kinds of discretion to executive bureaucracies that are found in parliamentary democracies, where the division between the executive and the legislature is blurred. Congress does, however, recognize the

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need for a substantial amount of expert bureaucratic authority. Thus, the FCC is allowed to deal with complicated issues where many of the detailed political costs and benets are difcult to determine. Congress then uses a variety of specialized controls to shape the power delegated to the bureaucracy. In the case of the FCC, Congress conrms the commissioners nominated by the President and stipulates the division of political representation of commissioners. It mandates a 32 split, with the Presidents party holding the majority and the chairmanship. This replicates the political sensibilities of the major parties within the majority voting system of the Commission. Commissioners introduce an element of political sensibility into the Commissions work, but normally have a narrower range of ideological divisions and a more technocratic slant than Congress. Congress also uses the power of the purse by threatening to use its budgetary powers to instruct the FCC on certain matters. For example, Congress directed the FCC not to use public funds to create rules to auction communications satellite spectrum. Similarly, the Congress requires transparency in decision making so that all of the key interests will have access to the decision process. This allows congressional members to observe the process with an eye to its politics, and to pressure the Commission if there is a compelling political interest. The net result is an FCC that is responsive to presidential and congressional politics, but legally empowered to make important discretionary policy. It is subject to judicial review for its adherence to a reasonable reading of the underlying law.12 It takes decisions based on its analytic judgment, the evidence on the public record developed in each procedure, and an instruction to use this discretion to serve the public interest. These expert and transparent, but politically informed, decisions shape market dynamics. A second feature of the U.S. political institutions matters for shaping policy. The presidential and congressional election system is based on winner-take-all voting. Analysts of electoral systems have shown that this voting system builds a strong interest in brand identity for political parties.13 Despite the role of lobbying and campaign contributions, parties invest to develop a reputation with policy initiatives on broad issues that they think will mobilize elite and mass electoral support. Naturally, ICT infrastructure policy mattered to the high-technology industry and research communities. It also achieved broad political salience to the voting public in two ways. First, as a matter of equity, there was continuing sensitivity to telephone pricing and service accessibility, and later broadband pricing. Second, infrastructure policy was part of the broader debates over economic policy, including the debates over deregulating the American economy and the creation of the new or Internet economy to stimulate growth. For example, the Clinton administration highlighted its telecommunications policy to polish its reputation as procompetition and pro-innovation Democrats.14 It bragged about early U.S. leadership in adopting the Internet. Similarly, the Bush administration later worried about the potential embarrassment of Americas lagging position on deployment of broadband. The third feature of the institutional context is federalism, the division of authority between the federal and state governments. The U.S. Constitution reserves all powers for the states that are not given explicitly to the federal government. Each

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state is allocated two Senators, regardless of its population. This increases the power of low-population farm and mining states at the expense of the large, urbancentered states. Federalism matters for ICT policy directly and indirectly. It has a direct impact, because the subsidy of rural communications users and providers is a powerful constraint on all regulatory policies inuencing pricing and competition. This spilled over from traditional phone services to computer networking in the 1990s as the Internet became a mass medium. It indirectly matters because federalism also provides a foundation for strong competition policy. State authorities often have used competition policy to shelter local competitors from nationally dominant competitors, and these local rms also enlisted the support of their senators. The key role of rural states in the Senate also heightened interest in competition rules that emphasized consumer welfare over the welfare of competing rms, because those states have less interest in industrial policy favoring national champions.15 The cumulative result was an American economy with broad geographic scope for its competitive rms and far less concentration in its key industries, including telecommunications and electronics, than its counterparts in other major countries.16 It also had a telecom market whose behavior was skewed by a pricing structure that bore little relationship to efcient costing. The implications for ICT infrastructure policy and architecture were profound. The Political Economy of Value-Added Competition: 19501983 The rst phase of convergence of computing, software, and communications began in the mid-1950s and extended through 1983. The existing telecom infrastructure was not well suited for the growth of computer networking. Transmission quality and throughput were optimized for voice networks, which made adding data networking capabilities difcult and expensive. Until the mid-1970s, network intelligence (computing power to guide connections and trafc routing on the network) was expensive and highly centralized in a set of switches at the top of the pyramid of less capable switches routing local and regional trafc.17 Network transmission capacity on pairs of twisted copper wires was also sparse, expensive, and specialized. It was expensive and physically difcult to expand capacity. Early computer networking services were slow and geared toward large business users. Quality voice services required 64 kbps, but data rates on these circuits were slower and less reliable. When computer networking took off, issues involving the quality, the speed of transmission, and related technical issues made the traditional networks practices inadequate for the new data networks.18 At the same time, the post-1945 era featured the growth of population and economic activity in the South and the West, thereby generating more demand for continental-wide networks and the growth of U.S. multinational rms. This put further pressure on an infrastructure that had been created and priced with an eye toward local and regional activities.19 Even with a national governing system prone to deadlock, policy evolution can move quickly if economic interests and political institutions are aligned, as was the case during the rst two ICT eras. Through the 1970s, the United States was

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economically distinct on the global scene, because it was by far the largest ICT market and its economy had a continental scope. Policies could stimulate new entrants while simultaneously retaining market scale and scope for incumbents. In addition, large enterprise users were deploying ICT as a central tool to enable new production and service processes to stay competitive nationally and internationallyairline reservation systems were pioneers in computer networking.20 Large enterprises also began using long-distance telephony intensively to increase branch coordination.21 This produced a group of large potential customers concerned with the markets organization among sophisticated rms. This in turn guaranteed an environment favorable for political entrepreneurship. The role of large users bears special attention, because in the postwar era, ICT gradually transformed them, thus intensifying their policy advocacy over time. ICT became more signicant then as a major cost factor for them. The United States was the worlds leader in multinational companies. In response to rising competition over time, its nancial institutions and many manufacturing rms have become information analysis companies, which deliver this information in the form of, for example, global nancial or engineering products. Global banks no longer focus primarily on checking or mortgages. At least until the nancial meltdown of 2008, their edge came from complex nancial products that rest on high levels of computing and global information operations that are rolled out quickly on a global scale over their ICT infrastructures.22 Multinational manufacturers know that the cost and quality of production are important, but the information-intensive, global design, and service functions are their critical edge. By the late 1980s, Boeing executives sometimes joked that an airplane is a ying software stack because there was more value added in the complex programming than in the sophisticated airframe.23 This fundamental shift in the strategic use of ICT drove these rms to become committed advocates for changes in ICT markets. The political institutional legacy of the American market structure shaped the way that these emerging interests played out. No rm legal basis for the national AT&T long-distance monopoly existed, and many smaller telecom carriers remained in small states and rural areas.24 This lacuna arose because it always proved politically difcult to craft legislation to authorize, or, later, to preserve a monopoly. In addition, a diverse industry of large and small electronics rms had grown to serve consumer, industrial, and defense markets. They lusted to supply equipment to American telecommunications networks. In 1956, their continuing complaints against AT&T beneting from research subsidized by monopoly utility rates led to a limited antitrust victory that forced Bell Labs to license its technology to them at little or no cost. Also in 1956, the rst limited liberalization of terminal equipment attached to the network was mandated. Then, in 1968, the FCC, in its Carterfone decision, started down the path to full freedom of competition in equipment attached to the network. Meanwhile, federal power sharing with the states over pricing policy and a Senate sympathetic to rural interests restricted the ability of AT&T to lower longdistance prices. So long as AT&T made high margins on long-distance service, it could then transfer part of the funds to support smaller rural carriers.25 Although AT&T offered special discounts to large corporate customers, it could not offer true cost-related pricing, so large customers continued to seek market change.

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The growth of computer networking, especially by IBMs smaller rivals, created another powerful set of motivated allies that were unhappy with AT&Ts dominance.26 An IBM plug-compatible industry grew up, which targeted the networking market. This led directly to the formation of a corporate competition coalition comprised of computer companies that wanted to create customized computer networks or feared AT&Ts entry into the computer equipment market. The computer companies were joined by large corporate clients, smaller electronics equipment vendors, would-be resellers of basic phone services, and government agencies, all seeking better deals.27 A new principle of modularity slowly emerged to guide governance.28 Modularity recognized that service and equipment reliability and efciency did not require uniform design and supply of a system. Instead, the system could be designed to allow a variety of subsystem designs and suppliers while still working together smoothly as a whole by requiring transparent and nondiscriminatory interfaces for components. This reasoning led to a reconceptualization of the market and the foundations for its regulations. It became common to distinguish among basic phone services provided over the general public network, the equipment that enabled it, and new advanced communications and equipment functions made possible by new electronic and computing technologies. Momentum grew to competitively deploy new value-added services and equipment. Liberalization of terminal equipment markets created the rst policy norm owing from modularity that drove equipment architecture. The norm held that new equipment attached to the network was acceptable if it did no harm to the network. The FCC nally recognized that the demands for computer networking required less restrictive equipment markets.29 This meant that equipment architecture had to allow for logically separate functionality with an open interface that allowed different pieces of equipment from any vendor to be linked together. A closed interface would not allow another vendors equipment to be linked. Although only incipient at the time, the no harm to the network norm implied a freedom of choice that grew into a second norm, technology neutrality. This norm deeply resonated with U.S. political and market institutions. America rarely picks civilian technology champions with any consistency.30 Its diverse economy does not easily generate political agreement on a single technology path for any market. By the 1980s, American policy makers also consciously doubted their ability to readjust their direction if they chose the wrong technology path, and so neutrality seemed a policy of substantive and political merit. This norm subsequently shaped the crucial choices made concerning the second generation of wireless technology introduced in the early 1990s. Unlike most other countries, the FCC opted for a policy of technology neutrality. The deployment of multiple wireless architectures resulted. The cost of diverse architectures was some confusion and delay in deployment of features requiring mass scale, although over the long haul, it had benets for innovation that emerged in the late 1990s. This was similar to earlier computer industry developments in the United States.31 At the same time, the Commission lurched toward allowing competition in the provision of networked computer services. In 1959, AT&T Long Lines established a discount rate for its largest corporate and government customers that was a reasonable proxy for a wholesale price for the leasing of transmission capacity to the

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new data networks. The FCC embraced this benchmark when it forced AT&T to lease capacity at a wholesale price to computer networks.32 In doing so, the FCC embraced for narrow purposes what eventually became a third norm, implementing modularitygovernment mandates requiring network operators with market power to share their network capacities with competitors on terms that would not restrict competition.33 In the realm of monopoly economics, government pricing intervention is complex because of the difculty the monopolist faces when trying to differentiate prices among different classes of customers whose elasticity of demand varies. It is also a political swamp because everybody makes special claims concerning rates. The political goal was to show that pricing was friendly to household consumers, especially in rural and low-income areas. This clashed with the logic of the networks cost structure. For example, costs were higher in rural areas where longer transmission distances supported fewer customers. Moreover, given the large common costs of networks, such as billing systems, attributing costs to different services and areas involved creative, albeit government-dictated, accounting. In general, the pricing formulas caused denser urban areas to subsidize rural areas, and long-distance customers to subsidize local service users.34 Monopoly had rested signicantly on its promise of preserving stable prices for local rates, and subsidized prices for rural and high-cost areas. A key political litmus test for these competitive reforms was whether they could be reconciled with these pricing arrangements. Over time, a quiet policy practice developed that the deployment of value-added, competitively provided services should not undermine the basic pricing and service structure of the general public network. By linking prices for sharing the AT&T network to an established rate (the wholesale price for large customers that existed under monopoly), the FCC laid the basis for skirting the political problems involving monopoly pricing. Anchoring the AT&T price for leasing to computer networks to existing pricing for large customers was politically reassuring because data services were added to a preexisting rate compromise that AT&T had promised would not upset consumer pricing. At the same time, side-stepping major pricing reform also opened the wedge for allowing private networks to join together geographically far-ung rms ofces with capacity leased from AT&T at wholesale rates. MCI applied for permission to provide specialized corporate services over its own microwave network in 1962, and in 1969, won approval for its rst link, between Chicago and St. Louis. When the FCC generalized this decision in 1971, only about 3 percent of the total Bell system revenue was at stake.35 The FCC also allowed private line carriers to interconnect with AT&T facilities. Predictably, the battle over the precise terms of interconnection led to MCI, and later to Justice Department suits, which led to the decision to divest AT&T that took effect on January 1, 1984.36 Even as telecom changed, IT also was restructured. IT in this era was characterized by deployments of computers of limited processing capacity clustered in central ofces, manufacturing plants, and research sites. A large share of the software was supplied by the computer maker. Early on, governments and large enterprise buyers were the major users of IT, and, later, networked IT. Just as in telecom, a combination of larger and smaller rivals and some big IT customers pressed for ways to curb IBMs early dominance of the market.

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In 1956, the IBM Plug and Play compatible antitrust decision partially separated hardware from software and led to the birth of the minicomputer industry. During the 1960s, further stresses to this industrial structure emerged as the growth of computer networking allowed new entry and software strategies in the IT industry, and integrated circuits became microprocessors. This allowed economies of scale in the production of chips by independent suppliers, a strong boost for rivals to IBM.37 Furthermore, experience with mainframe computing produced a growing pool of programmers who could write code independent of the big computer companies. Here, public policy was at the core of market evolution. The U.S. government antitrust suit against IBM led to a 1969 agreement that caused IBM to decouple hardware and software. This allowed the take-off of an independent software industry that featured packaged software.38 Although still a far cry from the software industry associated with the PC industry, this began to erode IBMs dominance and added to the move toward the modularity principle in computing hardware and software. Still, IT remained largely the domain of signicant data processing applications for the largest government and enterprise buyers. In short, the rst change in policy introduced the principle of modularity. The policy norms of no harm to the network, technology neutrality in government regulatory policies for ICT, and compulsory sharing of network capabilities by carriers with market power emerged. This approach initially was applied to create limited competition in value-added information services, private network services, and competition in terminal equipment. The debate over the terms for equipment competition, leasing of network capacity for the new computer networks emerging in the 1970s, and private corporate services smoothed the entry of the computer industry into the telecom policy realm. Computer vendors and their largest customers wanted to network expensive mainframe computers to allow more efcient cost sharing and operations. Networking became a major feature in struggles for future control of the IT industry, and all major technology suppliers and large network users pushed for policy change on networking.39

The Political Economy of Competing Infrastructures: 19842000 The break up of AT&T and the introduction of competition in the long-distance services and network facilities markets sparked a global revolution in the organization of the telecommunications industry. It made possible a further revolution in computing and broadcasting. By doing more than just forcing networks with market power to share their facilities on procompetitive terms, a second principle emerged for policy. The reasoning was that regulating the shared use of a monopoly infrastructure seemed complicated and unlikely to create innovations in infrastructure that might emerge from a network designed from scratch. At the same time, no entrant was likely to roll out a national network quickly, thus diminishing the value of network externalities (more connections make a network more valuable) for its customers. Over time, a second organizing policy principle took form: encourage the emergence of competing network infrastructures by removing legal barriers to their creation and by forcing the dominant incumbent to share its network with its rivals until competition in the market is robust.

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Why did change unfold as it did between 1984 and 2000? Why did change begin in the United States? If competition was driven mostly by technological and market forces, why did it unfold so differently in the United States than elsewhere? During the late 1970s, the combination of slow economic growth and high ination in the United States pushed deregulation of public utilities onto the presidential and congressional political agendas. Political parties strive to be national policy entrepreneurs. Democrats and Republicans both saw deregulation as a way to show their commitment to revive the American economy.40 The political economic interests of the corporate competition coalition reinforced their enthusiasm for deregulation. Renewed antitrust action during the Carter administration led to the break up of AT&T during the Reagan administration. The decision reected American political institutions. First, the courts followed established antitrust law favoring a consumer welfare standard that arose from the U.S. political economy. Second, the president and Congress cannot easily take decisive legislative action to steer an industry because it can be blocked at many points. This structural factor sidetracked AT&Ts attempt to legislatively assert its monopoly to repulse growing pressure from MCI and other upstarts and convinced a generation of entrepreneurial politicians that identication with AT&Ts critics was politically advantageous. Congressional Republicans and Democrats both were wary of protecting monopoly, as it became a national political issue. Even the Democratic Party, predisposed to supporting organized labor and therefore a likely ally of AT&T and its union members, spawned a generation of Atari (computer) Democrats critical of monopoly. Economic conservatives in the Republican Party joined them. This coalition sufced to block preemptive legislation to preserve the phone monopoly.41 Third, although many in the Reagan administration were wary of the AT&T antitrust decision, the White House did not try to overturn it, because the staff saw it as politically risky to favor monopoly.42 Fourth, the settlement made political sense because it could withstand pressures to protect incumbents before and after the AT&T breakup. The long-distance competition facing the new AT&T was balanced by monopoly phone services for the new regional Bells. This settlement protected both local and rural telephone service pricing. The FCC and state utility commissions could mandate cross-subsidies from long-distance carriers to local phone monopolies and still allow competition to improve services and lower longdistance pricinga rough rule of thumb was that until the late 1990s, the crosssubsidy amounted to about 40 percent of the revenue from a long-distance call. Competition yielded large efciencies and pricing much closer to underlying cost structures even with these cross-subsidies. As a result, long-distance prices dropped steadily and signicantly, a development that appealed to the middle class that tended to vote more than other Americans. Network competition also appealed to the corporate competition coalition because they received better prices and faster service innovations from the new entrants, which took special aim at the business market.43 The political compromise on rates produced numerous distortions in the market, but it was the price of a policy change. It is instructive to see how telecom pricing compared with the political and regulatory dynamics attached to the cable television industry. Cable began as a series of locally granted monopoly franchises and quickly

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won legislative favor as a way of delivering television to rural and urban areas with interference problems.44 In 1984, Congress passed a bipartisan Cable Act that ended local price regulation and banned the Bells from purchasing cable systems. The idea was that the still-young industry had an incentive to price attractively and would invest more aggressively than the monopolistic Bells. The legislation was especially attractive to Western members of Congress in both parties because of vast rural areas and the clustering of corporate headquarters for cable in that region of the country. As cable boomed, it became a powerful industry with revenues far exceeding the big three network broadcasters. In the late 1980s, as cable prices climbed rapidly and service remained spotty, it became a grass-roots consumer issue that crossed party lines. (This also gave the network broadcasters and the Bells a chance to strike back at their cable rivals by allying with consumer groups.) The ClintonGore campaign turned it into an issue to show that the White House was out of touch with consumers. Two-thirds bipartisan majorities in the House and Senate passed the Cable Rate Act of 1992 and overrode President Bushs veto (the rst Bush veto to be overturned). The Act instructed the FCC to work with local municipalities on capping cable rates, a sharp reminder that consumer pricing in the communications industry could prompt swift Congressional intervention.45 The outline of a regime that would dominate the United States emerged from the struggle over the fate of AT&T. The principle of favoring competitive network infrastructures built on the earlier norm of forcing dominant networksthose controlling essential bottleneck facilities, such as local transmission networksto share their capabilities with new rivals in order to promote rapid entry into the industry. This required detailed FCC supervision of dominant carriers on interconnection. The challenge was to police against bottlenecks in a way that allowed market forces to rationalize costs, stafng, and prices. Tools such as price caps and dominant carrier regulation were designed to foster procompetitive interconnection with new entrants and allow pricing rationalization.46 In addition to caution on pricing of local services, politics dictated two other policy practices. To cash in on the political promise of competition, regulators used competitive reforms to promote technological and service innovation for ICT, not just lower prices. Economic theory had long set the standard of maximizing consumer welfare. This practice claried what political leaders meant by consumer welfareit included technological innovation that was dear to the coalition supporting competition. In addition, policy makers were sensitive to employment effects. For example, they could allow labor stafng in dominant incumbents to decline, but needed to cushion job losses by encouraging the entry of new companies, which might offset the downsizing of old incumbents. Clearly, competition would lower the stafng levels from the days of monopoly, but there was enormous concern about the pace of adjustment. This mixture seemed politically successful. Prices for long-distance and data services dropped signicantly. Service innovation climbed. Computer networking continued, steadily progressed, and then exploded in the mid-1990s, when the importance of the Internet became apparent. Politicians could boast that the network revolution helped revive American fortunes in the computer and computer networking equipment markets.

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But this policy mix had implications for the market structure and infrastructure architecture that were less appealing. The AT&T divestiture created a logical segmentation of the physical infrastructure (between long-distance and local transport facilities) that forced the new AT&T to compete against entrants in the market segments where entry and competitive investments were easiestnot just in equipment but also in long-distance voice and data services. But it also created a monopoly for much of the national infrastructure and services, local communications, and, with minor exceptions, froze the regional Bell companies out of the long-distance and equipment markets. A generation of economists declared, however, that price performance for long distance would have improved more quickly if the Bells could compete.47 It also pushed the market in a direction where there were many new long-distance networks without comparable investment in local communications infrastructure. Meanwhile, there was consensus that the Internet and the Web would lead the next boom in communications and IT investment. The major corporate players wanted to be ready. The bargain leading to the 1996 Telecommunications Act was struck between a Republican Congress and a Democratic White House, each with reasons for wanting to reach an agreement. Predictably, the politically muscular regional Bells, which operated in all 435 Congressional districts, wanted permission to compete in all markets. Republicans sided with the Bells because their strength was greatest in the West and the South where the Bells were especially inuential, and the Republicans had won control of Congress in the 1994 election. By this time, Republicans had won much of the South, so Democrats (especially the White House) relied on a strong urban base where local costs of service were lower, demand for consumer long-distance and data services was high, and large users were concentrated. This tended to align Democrats with the long-distance carriers.48 The long-distance companies recognized that pressures for Bell entry were enormous, but they counted on Clinton White House support on the terms for their cross-entry into local services. The White House did so, but Democrats also were rebranding themselves as the procompetition champions of the information economy, so they did not want to oppose allowing the Bells to compete.49 During the legislative bargaining, the Bells rejected a deal that guaranteed them entry into the long-distance and data markets three years after passage of the Act. They thought that they would gain entry faster by meeting a check list of obligations on sharing their network functions with new competitors. However, a Democratic FCC, with strong White House support, interpreted the Act to call for strong interconnect obligations for the Bells at long-run incremental costs (a formula producing steep discounts). This formula enraged the Bells and the Republican Congress. Many economists, wary of heavy government regulation, worried that the FCCs approach might discourage investment by the Bells and induce inefcient, subsidized entry that rested on the Bells unrealistically priced facilities.50 The Bells launched a full-scale legal counterattack on FCC rules, and as American administrative bureaucracies enjoy less latitude than their counterparts in parliamentary democracies, court challenges tied up parts of the interconnection regulation. Still, market bargains on competitive entry were struck because the Bells wanted to claim

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that they had fullled the 1996 Acts checklist. They wanted to be free to participate in the anticipated boom in ber optic backbone networks being built in anticipation of the Internet and e-commerce frenzy. From 1998 to 2002, the demand for long-distance voice and data quadrupled, an impressive gure, but capacity grew 500-fold.51 This infrastructure later helped to kill the pricing structure for traditional long-distance carriers voice and data transport offerings.52 The much lower cost of data transport also facilitated further build-up of new web applications. But this was only part of the policy and architectural story. The emergence of the Internet, to use a clich, changed everything. The Internet was transformative because its straightforward route to interconnectivity of all networks soon overwhelmed the popularity of the existing formats underlying walled gardens for data networking (such as IBMs System Network Architecture) and email (like MCI Mail) that could hamper competition.53 By 1994, the Internet swamped commercial email services, and in August 1995, Netscape went public in the rst initial public offering (IPO) of the boom. In the United States, and to a limited extent elsewhere, new Internet services providers like AOL and MSN and later large content and e-commerce applications like Yahoo, @Home, and eBay, sprung up to take advantage of the power and scope of the network. The ingenious design of the Internet was largely a technology story (although the control of the design process had an important political element).54 In contrast, the deployment and use of the Internet, including its rapid emergence as the dominant way to network data, was closely linked to policy and politics. A critical feature shaping the growth of the Internet and the Web in the United States, and leading to decisive American leadership in their rollout, was a pair of telecom policy decisions with direct roots in earlier policy and political struggles over data networking. First, the FCC declared that telecom companies had to rent network transmission capacity to the new email/Internet companies at at rates and on technologically neutral terms. This allowed new entrants to substitute Internet protocols and architecture for approaches favored by traditional telecom carriers. Second, the FCC declined to allow the phone companies to impose a mandatory charge for dial-up Internet on a per call basis. Instead, consumers could dial into a local Internet service as part of their standard phone service. Essentially, this created at-rate pricing for unlimited use of the Internet and stimulated user experimentation with the Internet and the Web. No other country followed suit. Low costs and technological exibility were keys to experimentation by both users and Internet service suppliers.55 The change in consumer networking was part of a broader shift in the ICT architecture. As already noted, until the 1980s, the computer industry evolved in response to fundamental technological innovation in the chip industry and as a result of antitrust policies that unbundled the hardware and software industries. The introduction of the PC in the early 1980s represented the modular decomposition of the computer into the major value-added components of chips, software, and systems design and integration. Here, networking policy became critical. A crucial element of the success of the PC, compared with its early fate in Japan, for example, was the ability to use them in a networked deployment, rst over ofce LANs and then over national and global networks.56 This dynamic was fuelled in the

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United States by growing competition and innovation in the telecom markets. The deployment of the PC across the business and consumer landscape eventually fueled the growth of clientserver architecture in the enterprise, created new packaged software markets for enterprise (enterprise resource planning, productivity software) and consumer uses (word processing, graphic design), and dened the architecture for a whole generation of devices and applications. In the 1990s, the Internet further changed the scope of the network, network performance, and market-based networked applications, albeit largely still rooted in the PC architecture.57 In the two years prior to the Netscape IPO in 1995, the Internet/Webs dominance emerged from rivalry with competing computer networking systems. Its triumph came from a technological boost. In 1993, a critical series of government decisions and the wizardry of the web software began dissemination to those outside the research community. To begin, the competitive longdistance networks had ample, cheaply priced capacity in place for the new surge of data trafc. In addition, since 1984, the FCC had exempted value-added information services, the precursor to Internet messages, from the access charges that applied to long-distance trafc. As the Internet began to boom, the Bells quickly recognized the economic costs of foregoing access charges from Internet trafc. They pressed to reverse the decision, but the FCC, backed by a White House devoted to its new technology brand, resisted a formula that the FCC staff estimated would cost the average Internet user an average of $150 per month.58 The upholding of the 1984 policy allowed the at rate pricing that made the Web appealing to consumers over night. Technologically, the growth of Internet standards, data protocols, and application programming interfaces (APIs) beyond the control of any single platform vendor (such as Microsoft had exercised in regard to Windows) created momentum for more open APIs.59 A myriad of smaller, more specialized applications also emerged that built their businesses on powerful, cheaper PCs, broadband networking at the ofce, and widespread narrowband networking in the home. Changes in the network architecture and performance were coupled with the continuing transformation of computing by the personal computer and the growth of networked enterprise computing focused on enterprise resource planning and productivity suites.60 In short, the Internet cemented the architecture for moving forward in the ICT infrastructuredecentralized intelligence at the edge of the network (e.g., in terminals like PCs) would be critical to planning for networked computing. Once considered a controversial assumption, after 2000, this premise of the ICT infrastructure became embedded in policy and technological planning by all major market centers.61 The networking revolution cemented the dominance of the PC (and later, the smart terminal) for information technology. But it also created a classic political economy battle over the control of the value added tied to the PC. If telecom policy blunted control of telecom carriers over data networking, the politics of information technology turned over whether the PC could be leveraged to control commercial advantage on the Web. Thus, in theory, Microsoft might leverage its PC operating system (a bottleneck facility) to unfairly enhance its competitive Internet position at the expense of competition and consumer welfare. Worries increased that Microsoft

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would use its Internet browser packaged with Windows to promote its own software add-ons and content. The political economy logic of the Microsoft antitrust action tracks the history of U.S. electronics policy. Many large and small rivals located outside the Pacic Northwest, especially those in California, began a campaign to capture the attention of state and federal authorities.62 State actions eventually were picked up by a federal antitrust suit that produced a complex and controversial settlement with Microsoft. Economists continue to debate the merits of the suit, but the political economy of its logic tracked the story of telecom policy related here.63 In addition, the legal action gave a clear signal that architectures for software and the Web faced major risks both in the courtroom and from wary customers if they did not extend the principle of modularity to the software ecosystem. Thus, by the early twenty-rst century, modularity had emerged with a vengeance in the Web 2.0. Even Microsoft opened its interfaces in ways totally unlike the 1990s.64 Conclusion: The Path of Technology and Political Economy Considerable attention has been given to nding which system of government intervention in technological innovation works best. Here, we concentrated on a prior analytic step. We asked if political economy played an identiable role in shaping one of the largest waves of technological and commercial innovation in modern history, the revolution in telecommunications and computer networking. We argued that the amount of competition is only one factorthe particular policy mix for competition also matters, and this policy mix reects fundamentals of political economy. In the case of the United States and the digital revolution shaping the ICT infrastructure, we offered three arguments concerning the impact of political economy and policy on the architecture of the ICT infrastructure. First, it tilted toward an architectural principle of modularity whose implementing policy norms inuenced the paths of both the telecom equipment, computer equipment and software, and computer networking markets. Second, it created multiple network infrastructures for telecommunications when other countries either tried to retain a monopoly infrastructure or carefully limit the number of competitors. It also created a pricing system that exempted data ows from the cross-subsidies associated with long-distance voice trafc. Third, it propelled both a particular architecture for computing (intelligence at the edge of the network) and the full realization of the potential benets of the Internet. The United States did not just embrace competition in networking traditional telecom and new information services. The policy mix for competition shaped the architecture of the ICT infrastructure, ultimately resulting in the triumph of the Internet and the Web in the United States. This breakthrough reverberated globally and created a truly World Wide Web. Notes
1 The authors would like to thank the Sloan Foundation Industry Studies Program and the collaboration of The Berkeley Roundtable on the International Economy and The Research Institute of the

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2 3 4

5 6

7 8 9 10 11

12 13 14 15 16

17 18

19 20 21

Finnish Economy for enabling two conference panels and a research workshop in which these articles were developed. The comments from two anonymous reviewers and fellow contributors to this issue were much appreciated. Zysman and Newman (2006). In this paper, we will treat policy principles as a widely shared view concerning causal dynamics. We will treat policy norms as the specic premises for particular clusters of policy decisions. More technically, modularity means that components that work together interoperate through transparent, nondiscriminatory interfaces. Interoperability requires (1) the technological capability to build separable inputs at competitive prices; and (2) making design choices that ensure that interfaces connect seamlessly. See the discussion in the third part of the article. The development of these particular technologies in turn have inuenced the trajectory of growth and utilization of said innovation in other countries, shaped by their own specic political economic constrains; for two examples, see Dossani and Kenney on India, and Kushida and Zysman on Japan and South Korea (Dossani & Kenney, 2009; Kushida & Zysman, 2009). We explain how the AT&T monopoly over all terminals attached to the telecom network was ended later in the text. Smart critiques of claims concerning optimal innovation structures are: Breznitz (2007) and Taylor (2007, 2009). Cowhey and McCubbins (1995). Tsebelis (2002). One congressional check on the power of the FCC is the sharing of some of its powers with other branches of the government. The most important of these is the shared power over competition policy with the Antitrust Division of the Justice Department. Given the strength of U.S. antitrust laws, both political parties are sensitive to the possibility of the rival party politicizing competition policy when it controls the federal government. As a result, the career ofcials in the Antitrust Division enjoy a relatively high level of protection from routine political meddling. Decisions on the general criteria for when to prosecute are subject to guidance by a political appointee, but the White House is generally circumspect on antitrust matters. Congress wrote the terms of judicial review in the 1934 Act to shape its implementation (Shipan, 2000). The evidence is evaluated in Cox and McCubbins (2007). Hundt (2000). On the impact of institutions on telecom policy, especially federalism and pricing, see Noll and Rosenbluth (1995). Between 1900 and 1933, as national industrial and network markets took form, state authorities used antitrust actions to shelter local competitors from national competitors that held advantages over them. Most senators from these states were wary of nationally dominant rms. Americas veto-oriented system and Congressional distrust of sweeping regulatory powers dampened impulses toward national economic planning. Industrial policy that might have concentrated rms into a few national champions was difcult to pass. It should be noted that fostering the interests of smaller rms is often confused with a pure economic test of consumer welfare (Cowhey, 1990a). On the structural differences among states over the sweep of Congressional history, see Brady and McCubbins (2002). On states in early antitrust actions, see Bringhurst (1979). Electronic switching began to supplant mechanical switches, but the rst digital switches did not enter service until the 1980s. Telecommunications and broadcast required separate transmission networks. Even the introduction of two new broadcast infrastructures, cable and direct satellite broadcast to the home, were dedicated specialized infrastructures. The advent of satellite communications services in the 1960s helped long distance, and, later, broadcast to the home. At rst, it did little for data transmission. Fiber optic transmission began to enter the network in 1977. Senators used hearings to pressure the FCC to make sure that lower interstate rates for national rms did not harm local in-state rates (Temin & Peters, 1986, pp. 324327). On the evolution of software and computer networks, see Campbell-Kelly (2003). Cortada (2005, pp. 33, 8990) reports various estimates of ICT as the costs of the largest banks. His estimates are in the range of 715 percent of the total costs of the banks. As late as 1992, after networking costs had declined dramatically from the 1970s, networking costs were 10 percent of the

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22 23

24 25 26 27

28 29

30 31 32

33

34 35 36 37

38

39

40 41 42

43

44

45

46

total. Interviewing and documents supplied to the authors in the 1980s showed that during the 1970s, networking costs were much higher. Siems and Yucel (2005, pp. 1316). Jacobides, Knudsen, and Augier (2006). Conversation with one of the authors. These changes were part of the broader transition to being a service economy that eventually made sophisticated manufacturing into a part of service product schemes, as what happened in ICT (Castells, 1996). Mueller (1997). Brock (1994, pp. 6574). Defenders of AT&T decrying the courts are exemplied by Temin (1987). Cowhey (1990a). Large customers sought volume discounts and customized service packages for internal private networks. Computer services, including networking, were protable but were on a smaller scale than today. Sales of IBM computers in 1984 were $22.2 billion. The combined revenue of the top ve computer services rms was $3.4 billion, computed from Datamation gures reported in Chandler (2001, pp. 118119). The high level of oligopsony in communications use is reported in Cowhey (1990b). Farrell and Weiser (2003). Eventually, the FCC ordered AT&T to create a separate subsidiary for terminal equipment because of issues concerning cross-subsidies in the competitive equipment market. The FCC did not think that these decisions would cause local phone rates to balloon (Brock, 1994, pp. 7998). Cohen and Noll (1991). The funding of research leading to the Internet was not an exception. Nobody saw the Internet as commercial data architecture until late in its deployment. On the U.S. and global policy choices and politics, see Cowhey, Aronson, and Richards (2006). The FCC was not allowing the building of an alternative network so it had to regulate the price on which competitors could lease capacity from the monopoly network. We thank Gerry Faulhaber for the point concerning wholesale pricing. The FCC went further than this. During a key phase of the markets growth it restricted AT&T from offering computer information services. One reason why AT&T eventually agreed to its breakup was to gain entry into this market. Waverman and Crandall (2000). Brock (1994, p. 118). Coll (1986, pp. 1819, 169171). AT&T licensed the transistor to other companies in 1952. In 1959, Texas Instruments and Fairchild introduced the integrated circuit. In 1971, Intel created the microprocessor. IBM introduced its PC in 1981. In 1986, Cisco introduced the TCP/IP router. Timeline from Chandler (2001, pp. 262265). In 1963, DEC made its rst meaningful impact in the marketplace with its minicomputer that permitted computers on the factory oor (Chandler, 2001, p. 104). On the politics and economics of the IBM court battles, see Fisher, McGowan, and Greenwood (1983). By the late 1970s, the Japanese had emerged as the major potential competitor to the American computer industry. These Japanese rms saw computer networking as a key part of their strategy. So, it was no surprise that the United States and Japan had bitter trade disputes in the mid-1980s over the terms for competition in global computer networking precisely because of its importance for IT leadership (Flamm, 1987, 1988). Breyer (1982). See the essays on Congressional action in Shooshan (1984). The classic blow-by-blow account of White House thinking, including why it would not overturn its own Justice Department, is Steve Colls The Deal of the Century (1986). Colls account shows that the Justice Department and the federal district court hearing the case were not out of control, as many critics complained. The critics simply had a losing political argument. All major telecom carriers, including the new entrants, were unionized, so a decline in employment at AT&T was partly offset by new employees at MCI and other rms. This reduced the resistance of organized labor, a major constituency of the Democrats. The industry proted from the same antitrust legacy that shaped telecom policy when the Justice Department in 1953 forced the dominant equipment supplier for cable to divest its network holdings. It had made acquisition of an ownership share into a condition of supply to cable networks. Neucherlein and Weiser (2005), Digital Crossroads, chapters 11 and 12, succinctly analyze broadcast policy. Fascinating journalistic accounts, with some erratic polemics, are: Keating (1999) and Robichaux (2002). Noam (2001).

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47 The Bells continued to be cross-subsidized by inated, but nondiscriminatory, fees charged to long-distance carriers for local transport. Thus, politicians knew that local prices would be stable, while long-distance prices continued a faster decline than before the AT&T divestiture (Crandall, 1991). 48 The Democrats also wanted to distinguish new forms of subsidy for consumers from programs identied with the welfare of the Bells. Despite grumbling from the Republican Congress, the FCC used its discretion to institute a new fee for telecom services to fund the establishment of Internet access for schools, libraries, and hospitals. This was a conscious decision to meet the political demands to keep service widely distributed to all areas, but the Democrats designed the subsidy so that it went as much to poor urban neighborhoods as it did to rural areas. Inevitably, coverage of middle-class areas was part of the political bargain. 49 There were divisions in each party. But the median point of each partys Congressional caucus was signicantly different. Conservative Republicans cast this as enhancing competition by taking regulatory shackles off the Bells. Clinton Democrats stressed enhancing competition by letting new entrants attack the local transmission bottleneck on the network. 50 Representative critiques were: MacAvoy (1996), Willett (2002), and Houseman and Sidak (2004). Neuchterlein and Weiser (2005, chapter 3) offer a nuanced law and economics analysis. 51 There was also investment in competitive local infrastructure, but the boom in long-distance networking occurred because everyone overestimated demand and underestimated the speed at which pricing would decline. It was also clear that entry into long-distance and long-haul data transport had the lowest regulatory and engineering barriers. Of course, by 2001, the rst Internet boom zzled, but across America and under the Atlantic and Pacic Oceans, a huge new installed infrastructure of ber optic transport remained. 52 The collapse of Global Crossing after it completed massive ber optic submarine cables linking the United States and Asia allowed for the outsourcing revolution in India and elsewhere (Friedman, 2005, pp. 103106). 53 The beginnings of internetworking dated from the mid-1980s (Cisco shipped its rst router in 1986) when companies and network providers began to interconnect their networks. U.S. policy changes in 1991 enabled the commercial use of the Internet, setting the stage for the growth of the Internet during the 1990s (Bresnahan & Greenstein, 1999, pp. 140). 54 Cowhey and Mueller (forthcoming). 55 Bar and others (2000). 56 Cole (1996). 57 In Japan, this innovation storm, driven by lower costs, exible networking, and user coinvention, was absent. Japan continued to favor vertical integration anchored on the technological planning of the dominant NTT. Although Japan also introduced telecom services competition, it limited the impact of competition by placing all new entrants under a micromanaged price umbrella set by NTT. Network expansion plans need ministry approval. Because the government wished to sustain its subsidy scheme for electronics rms, Japan required the licensing of value-added networks. It did not license a network embracing Internet protocols until 1992 (Greenstein, 2005). 58 This estimate was based on the Bells getting the full equivalent of voice access charges (Hundt, 2000, pp. 133135, 206207). 59 Amid the notoriety of the Microsoft litigation, an important legal right emerged that allowed software developers to reverse-engineer software interfaces to create complementary and substitute software. This trend, praised by most leading analysts, occurred in both the United States and the EU (Samuelson & Scotchmer, 2002, pp. 15771633; Greenstein, 1993, pp. 3651). 60 On PCs, see Chandler (2001); Ferguson and Morris (1993). The PCs operating system supported new packaged, mass consumption, software applications, and spurred enormous investment and innovation around PC-based software. Declining price/performance rations opened the door to widespread deployment and the adoption of vast enterprise software packages to manage processes and data across the enterprise. Packaged software for PCs also opened the way to greater complementarity of software products, particularly between the Microsoft software platform and specialized software applications. This created a new set of hardware and software industries focused on the PC ecosystem (from mice to games to all variety of semiconductors). The emergence of the Internet, and in particular, a new PC application used to browse content and services, reinforced the client-server architecture that dominated enterprise architectures (Richards & Bresnahan, 1999, pp. 336371). 61 See Cowhey, Aronson, and Richards (2006) for evidence.

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62 These issues also were raised over the AOL-Time Warner merger but in that case the operational remedy was low key, the Federal Trade Commission chose to treat the issue as one of leveraging bottleneck facilities. See the review by Faulhaber (2003, pp. 7397). 63 Evans, Hagiu, and Schmalensee (2006). 64 Ironically, the changes induced by modularity and competition in the 1990s later changed the political economy of ICT after 2000. Cowhey and Aronson (2009).

About the Authors

Peter F. Cowhey is the Associate Vice Chancellor, International Affairs at the University of California, San Diego. He also holds there the Qualcomm Endowed Chair in Communications and Technology Policy. His research has spanned the politics, economics, and policy of energy, telecommunications, trade, and biosecurity. His work has appeared in International Organization, Foreign Affairs, and International Studies Quarterly. His new book (with Jonathan Aronson) on the political economy of ICT infrastructure development will be published by MIT Press in 2009. Jonathan D. Aronson is a Professor at the Annenberg School for Communication and the School of International Relations at the University of Southern California. Professor Aronsons work focuses on international political economy with special attention to trade negotiations, trade in services, comparative regulation, international strategic alliances, and especially international telecommunications. John Richards is a Research Scholar at UC San Diegos Global Information Industry Center. His areas of research focus on the competitiveness and regulation of international information technology and telecommunications markets. More broadly, he has published extensively on the evolution and regulation of international markets in network-based industries (telecom, IT, aviation). John held posts in the Stanford Economics Department and McKinsey & Company. He currently works at Microsoft in their online services group.

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