Economic Report President

Justice Department’s challenge represents an important applicationof antitrust policy to the particular problems of competition andinnovation in network industries.Telecommunications and the InternetNetwork effects have been essential to the structure and regulationof telecommunications. At the beginning of this century communitieswere often served by competing telephone systems, with AT&T and analliance of independent companies each taking about half the market.Generally, the competing systems refused to interconnect with eachother and exchange traffic, and so a customer could only call peoplewho subscribed to the same network. Eventually, AT&T was able to tipthe market in its favor by patenting superior long-distance technologyto which subscribers of competing telephone companies were deniedaccess. This gave consumers an incentive to switch to AT&T, and thecompany grew into a nationwide monopoly.In 1984 the Federal Government broke up AT&T’s integratedmonopoly into a long-distance company and seven regional companiesproviding local telephone service. Each of these seven companies stillhad a monopoly over the local service network in its region. TheTelecommunications Act of 1996, however, opened the door to local telephonecompetition by requiring the regional monopolies to, amongother things, interconnect and exchange traffic with new entrants intothe market on nondiscriminatory terms. From the standpoint of networkeconomics, this provision makes entry easier by allowing anynew telephone company, no matter how small, to offer consumers thesame network benefit as a larger carrier.Preserving competition has also been a regulatory priority intelecommunications networks other than the telephone system. Internet“backbone” providers transport information between the highcapacitycomputer networks that make up the Internet. They sell theirservices to businesses, institutions, and the Internet service providers(ISPs) that offer Internet access directly to consumers. They also negotiateterms for the exchange of traffic with each other to provide theuniversal connectivity that defines the Internet. When MCI CommunicationsCorp. and WorldCom, Inc., which in addition to their otherlines of business were two leading backbone service providers, weremerging in 1998, the Justice Department required MCI to divest itsInternet backbone business to an independent competitor. Without thedivestiture, the merged company would have had substantial controlover the transport of Internet traffic, making it more tempting toreduce the services it provided to rival networks with which itexchanged traffic. The Department’s enforcement action thus helpedpreserve competition in the backbone market and ensure that nosingle company could dominate the “network of networks” that comprisesthe Internet.191