The great telecoms crash

“TODAY, there is no economy but the global economy, no Internet but the global Internet, and no network but the global network,” wrote George Gilder, a technology guru, in February 2001. He predicted that two telecoms firms, Global Crossing and 360networks, “will battle for worldwide supremacy, but in a trillion-dollar market, there will be no loser.” Yet within a year, both had filed for bankruptcy—a graphic illustration of how quickly the industry's titans have been toppled. There were losers after all: banks and shareholders, who are now smarting from enormous debt write-offs and precipitous declines in telecoms share prices.

The past few weeks have seen general falls in stockmarkets in America and all round the world, in many cases to six-year lows. These have been interspersed with ineffective efforts by President George Bush to reassure investors that economic fundamentals are sound and that corporate America is in better shape than recent scandals might suggest. There is good reason to worry about a new recession, and not only in the United States, yet for the moment the data do not support this concern. Where the pain can readily be seen is in the industry at the heart of the corporate malfeasance: telecoms.

The telecoms bust is some ten times bigger than the dotcom crash. It is crucial, for both financial markets and the world's economies, that the industry climb out of its hole

The telecoms bust is some ten times bigger than the better-known dotcom crash: the rise and fall of telecoms may indeed qualify as the largest bubble in history. Telecoms firms have run up total debts of around $1 trillion. And as if this were not enough, the industry has also disgraced itself by using fraudulent accounting tricks in an attempt to conceal the scale of the disaster. WorldCom, which “misclassified” $3.8 billion in network-maintenance costs as capital spending so as to hide huge losses, teeters on the verge of bankruptcy. If it goes under, it will be the biggest failure in business history, putting even Enron's demise in the shade.

All this means that it is crucial, both for financial markets and for the world's economies, that the telecoms industry should now climb out of its hole. It faces years of painful reorganisation, as the oversupply of capacity built during the boom years is brought into line with demand, and the mountain of debt is restructured (see article). There will be more bankruptcies among erstwhile high-flyers. In America, there is a risk of a vicious circle: as companies emerge from Chapter 11 having shed their debts, they may undercut debt-laden rivals, causing further collapses. In Europe the former monopoly incumbents, such as Deutsche Telekom, which shed its chief executive this week (see article), can be sure that their governments will not let them fail. But they too must reduce debts by selling assets, backing out of loss-making overseas ventures to retrench in their home markets, and issuing new shares. On both sides of the Atlantic, once new management is in place and investors are reassured that no new accounting skeletons lurk in closets—not any time soon, in other words—an enormous round of consolidation must begin.

The likely winners are the former “Baby Bells” in America and the former monopoly incumbents in Europe

The likely winners, it is already clear, are the former “Baby Bells” in America and the former monopoly incumbents in Europe. Because they own the “last mile” of the network that runs into homes and offices, these operators have a firm grip on their customers and solid revenues. Compared with their upstart competitors that proliferated after the liberalisation of telecoms markets during the 1990s, these firms are relative safe havens. Customers can switch long-distance carriers at the first whiff of trouble, but often have no choice of local provider. In theory, regulators should require local monopolies to allow competitors to provide services over their lines, but most local monopolies have successfully obstructed such “local-loop unbundling” using a variety of technical excuses.

In a further sign that local operators are seen as a safe haven, Michael Powell, America's telecoms regulator, even signalled this week that he would consider allowing one of the Bells to buy WorldCom. The antitrust rules that now prohibit the Bells from fully entering the long-distance market might, in other words, be set aside. Meanwhile, the Bells are pushing for regulatory concessions that would let them establish new monopolies in high-speed “broadband” Internet access, and have won a number of recent victories.

With the upstart competitors flat on their backs and the local monopolies once more calling the shots, the telecoms landscape could soon come to look much as it did in the days before liberalisation. It is tempting to conclude that the natural-monopoly economics of telecoms have simply reasserted themselves—and that liberalisation was a big mistake.

Let 1,000 bells ring

Tempting, but wrong. Liberalisation has provided unquestioned benefits for customers. The emergence of competitors has compelled former monopolies to stir themselves, cut prices, introduce new services, and abandon any notion that the world owes them a living. Look at the way the cost of long-distance calls has fallen in recent years, or how the popularity of mobile phones has grown. Both are direct results of competition. It is true that the bust's ultimate cause was that too many competitors decided to build enormous networks for which there was little demand. But that does not justify a return to the industry's monopolistic past.

It is tempting—but wrong—to conclude that liberalisation was a mistake

The danger is that the traumatic scale of the telecoms crisis will cause the pendulum to swing back too far in favour of the former monopolies. In the short term, they are likely to attract investment, to pick up the assets of bankrupt rivals, and to lead the way in consolidating the industry. This will provide some welcome stability. But it would be wrong to grant the former monopolies any regulatory concessions now that would protect them from competitors in future.

Once today's bust is over, too much power concentrated in the hands of the former monopolies could let them raise prices and stifle the deployment of innovative technologies. The one thing that keeps would-be monopolists on their toes is viable competitors. It may be hard to imagine just now, but such competitors are sure to re-emerge in telecoms one day. And when they do, governments must ensure that the regulatory door has been left open to let them in.