This work is distributed as a Discussion Paper by the

STANFORD INSTITUTE FOR ECONOMIC POLICY RESEARCH

SIEPR Discussion Paper No. 02-07 Coordination and Decomissioning:

NSFNET and the Evolution Of the Internet in the United States, 1985-95

By Eiichiro Kazumori Stanford University

February 2003

Stanford Institute for Economic Policy Research Stanford University Stanford, CA 94305

(650) 725-1874 The Stanford Institute for Economic Policy Research at Stanford University supports research bearing on economic and public policy issues. The SIEPR Discussion Paper Series reports on research and policy analysis conducted by researchers affiliated with the Institute. Working papers in this series reflect the views of the authors and not necessarily those of the Stanford Institute for Economic Policy Research or Stanford University.

COORDINATION AND DECOMISSIONING: NSFNETAND THE EVOLUTION OF THE INTERNET IN THE

UNITED STATES, 1985-95.

EIICHIRO KAZUMORI

Abstract. The objective is to examine the role of public policyin the development of the Internet in the United States. Untilthe middle of 1980s, the lack of interoperability delayed the wideadoption of computer networks. In 1985, the National ScienceFoundation created the first public national backbone NSFNETusing a nonproprietary TCP/IP network protocol. It also provideda seed funding for the regional networks. These policies eased thecoordination failure and created the critical mass for the growthof networks. Second, in early 90s, the NSFNET was privatizedat a relatively early stage. This early privatization avoided theregulatory capture and inertia. This combination of coordinationand early privatization can be a useful framework for an economicdevelopment policy.

When historians look back the latter half of 1990s adecade or two hence, I suspect that they will concludewe are now living through a pivotal period in Americaneconomic history. New technologies that evolved fromcumulative innovations of the past half-century have nowbegun to bring about dramatic changes in the way goodsand services are produced and in the way they are dis-tributed to the final users.... How did we arrive at sucha fascinating, and to some, unsettling point in history?- Alan Greenspan, March 6, 2000.

1. Introduction

1.1. The statement of the problem. The Internet has a profoundimpact on economic activities. Some people compare its impact withthose of the past industrial revolutions. In economic history, we askwhy the first industrial revolution took place in England, not in France

I would like to thank seminar participants at Stanford Computer Science De-partment Multiagent Group and the International Society of New InstitutionalEconomics 2001 for helpful feedbacks.

1

2 EIICHIRO KAZUMORI

or some other countries. In this paper, we ask, why the Internet firstevolved in the United States, not in Japan or some other industrializedcountries. Answering this question would be meaningful in terms ofeconomic history and economic development.

1.2. A review of the previous literature. In spite of the impor-tance of this question, the previous research has not yet identified theanswer. We divide previous research into the three areas of computerscience, strategic information management, and some recent works byShane Greenstein.The first one is a historical study of computer technology. A repre-

sentative recent work is Abbate (1999). It identified the role of federalgovernment in the technological development in ARPANET. Neverthe-less Abbate (1999) did not deal with the interaction between the publicnetwork and commercial networks. For example, Abbate (1999) doesnot mention the electronic data interchange or X.12 protocol.Second, in the area of strategic information management, there is re-

search on the adoption of electronic data interchange at the micro level.A representative work would be Pfeiffer (1992). His analysis tested sev-eral hypotheses on the adoption and execution of the electronic datainterchange. Nevertheless, he did not substantially discuss the role ofpublic policy beyond the standardization of communication protocols.In addition, since it is a micro-level study, there is no discussion of theglobal adoption of the network.Finally, Shane Greenstein (1997, 1999, 2000) has studied the devel-

opment of ISP markets after the privatization of NSFNET in 1995.Nevertheless, his analysis does not go back before 1995 and does notask the question of why the Internet has evolved at all.

1.3. Our approach. Here, we propose a hypothesis that an institu-tional factor played a significant role in the development of the In-ternet in the United States. Specifically, we study the role played byNSFNET, a project by the National Science Foundation from 1985-95.Our argument is summarized as follows:In the early history of data communication networks, in spite of its

technological feasibilities, coordination failure delayed the wide adop-tion of the computer network. Most of the technologies used in theearly Internet were available since 1970s. For example, TCP/IP wasproposed in 1974. WAN/LAN was available in ARPANET since 70s.Ethernet was proposed in 1974.But the coordination problem delayed the wide adoption of these

computer network technologies. The network service providers had of-fered only non-interoperable proprietary networks to lock-in customers.

THE INTERNET 3

This lack of interoperability prevented the realization of returns toscale. Thus, as earlier research shows, in spite of technological feasi-bility, the diffusion of electronic transaction was in the 70s and early80s.The first role played by NSFNET was coordination. The NSF estab-

lished NSFNET in 1985. It was the first public computer network back-bone that connected almost all of the existing networks. In contrast,the previous ARPANET, run by the Department of Defense, limited ac-cess to the researchers with the DARPA contracts for security reasons.In addition, NSFNET adopted TCP/IP as a communication protocol.TCP/IP has been non-proprietary and widely available from BerkeleyBSD Unix distributions. Moreover, the NSF provided the seed fundingfor the creation of regional networks. These regional networks for thefirst time connected local universities, governments, and businesses overthe computer network. Given that incumbents’ commercial networkswere reluctant to adopt nonproprietary network protocols, this policywas effective in creating the critical mass. As a result, the number ofcomputer hosts connected to this Internet dramatically increased after1986.

[Figure 1.1]The second role played by NSFNET was the privatization at an early

stage. As NSFNET grew, the NSF needed to delegate its managementto a consortium ANS of IBM, MCI, and Merit. ANS had an exclusiverights over commercial access to the national backbone. Therefore,there was a potential conflict of interests between ANS and private ISPsabout connection to the backbone. This led to a congressional hearingin 1992. As a result, the NSFNET Act of 1950 was amended to permitcommercial traffic. In addition, in the process of privatization, theNSF created the NAPS (national access point) where the local Internetservice provider can access the private national backbone providers fora low charge. This mitigated the exercise of market power by theprivate national backbone providers. As a result, the general publicand businesses have access to an inter-operable, large-scale computernetwork at a relatively low cost. Therefore there has been a bandwagonshift from a low adoption equilibrium to a high adoption equilibrium.

1.4. Lessons for development policy. There are two lessons to belearned from this case study. First, our approach emphasizes a dy-namic relation between the government and the private sector. Thetraditional debate about the relation between public and private sec-tors focuses on the question of whether government intervention andprivate sector performance are complements or substitutes. In contrast,

4 EIICHIRO KAZUMORI

we claim that this relation can depend on the stage of the market de-velopment. In the initial stage, coordination by the government canincrease the private sector investment by easing the coordination fail-ure. But after the critical mass is achieved, interventionist governmentcoordination may not be necessary. Moreover, as the technologicalcomplexity increases, it becomes more difficult for the government tocompute the optimal allocation. As a result, it would be more sociallyefficient for the government to leave the allocation to the market.Second, our study shows that different branches of the government

play different roles in the stages of the development of the Internet.In the early stage, the members of the administrative branch, such asNSFNET, played a key role in the resolution of the coordination fail-ure. This could be in some conflict with the interests of the traditionalcommercial network service providers, and thus may not be substitutedby the other branches of the government. In the next stage, the legis-trative branch played a key role in the privatization of NSFNET. Theintervention by the legistrative branch was important to balance theinterests between the public network and the private networks. In thefinal stage, the judicial branch might play an important role in sustain-ing efficient industrial structure, perhaps through the enforcement ofanti-trust legislation.

1.5. The plan of the paper. The roadmap of the paper is as follows.In the next section, we provide a brief introduction to the computernetworking. In section 3, we study the early history of electronic com-merce. In section 4, we cover the coordination phase of the NSFNET.In section 5, we discuss the privatization process. Section 6 concludes.

2. Introduction to computer networking

In this section we review the basics of computer networking tech-nology for the readers who are not familiar with this area. We startfrom the simplest case of the network between two computers. Thenwe move to the situation of LAN (local area network). Finally we dealwith the case of WAN (wide area network).

2.1. Network of Two computers. The computer networks are de-fined as the interconnected collection of autonomous computers. Here,two computers are interconnected if they are able to exchange informa-tion. Also computers are said to be autonomous if there is no computersuch that there exists another computer which can shut off that com-puter forcibly.

THE INTERNET 5

Application

Transport

Internet

Host-to-Networkl

Application

Transport

Internet

Host-to-Network

Host 1 ( Sender ) Host 2 ( Receiver )

TELNET, FTP,SMTP, DNS

TCP, UDP

IP

APRANET, LAN,RADIO

Figure 1. TCP/IP Model

Consider the simplest case where one computer sends data to anothercomputer and both computers have the TCP/IP connection. The com-munication process is decomposed into four parts: application, trans-port, internet, and host-to-network.The first part is the application layer. This layer contains the stan-

dard office software such as FTP (file transfer protocol), TELNET(virtual login), SMTP (simple mail transfer protocol), and DNS (do-main name system). The function of this layer is to provide access toapplication programs. Consider a case where the sender wishes to sendan electronic mail. First, a user composed an electronic mail using asoftware based on SMTP protocol. Then the software puts the mail asa file in the file system. Then the protocol picks up the email. The pro-tocol goes to the DNS system to find out an IP address of the sender.Then the communication process goes to the next step of establishingTCP (transfer control protocol) connection.The next part is the transport layer. This layer contains the TCP

and UDP software. The function of this layer is to provide end-to-endcommunication between hosts. First, the TCP software establishes theconnection using sockets between two computers. Second, the softwaredivides the data into packets of small size. The software attaches theheaders which includes the information about the destination addressto each packets. Finally, the software controls when to send thesepackets based on the congestion situation of networks.The third part is the network layer. This layer contains IP software.

The function of this layer is to set up the transmission path betweencomputers. Specifically, IP attaches the IP header which includes the

6 EIICHIRO KAZUMORI

identification for the packet. Then the IP sends the packet to thedestination.The final part is the physical layer. This layer consists of the actual

transmission medium such as the copper wire or wireless. At this layer,the data is transmitted as an electronic signal.Note that this example is the simplest case where both computers

support TCP/IP internet protocol. But in reality there are two issueswhich makes the transmission of data impossible. The first problem isthe case where a computer adopts different protocols, such as SNA byIBM. In that case, the data communication problem is not trivial dueto incompatibility between protocols. This problem will be discussedlater.The second problem is the case where the companies want to send

business data in the electronic data interchange (EDI). In this case,even if the computer communication protocols are compatible, if theformats for business data are incompatible between two computers, itis impossible to exchange data. These sources of incompatibility willbe discussed later.

2.2. Local Area Network. Now consider a case where one computerin a cabling network wants to send data to another computer in thenetwork. In the previous case, since there is one transmission mediumfor two computers, the computer can always use the medium. But inthis case, since there are more than two computers for one medium, weneed to handle the possibility of conflict between traffic. This is thereason that we need a new class of mechanisms, which is called LAN.LAN is defined to be a data communication system with multiple

devices, such as computers and printers, located within 500m or less ofone another. An example of LAN is a computer network in a universitydepartment.Physically, a LAN consists of three elements. The first one is a

transmission medium such as coaxial cable, copper wire, or fiber opticcable. The second one is the hardware which connects the transmissionmedium to a computer such as network interface card (NIC). The thirdone is the LAN-specific software to control the transmission process.This software will be located in the transport layer in the communica-tion layer model discussed in the previous subsection.There are three types of LANs: bus (Ethernet, IEEE 802.3), token

bus (IEEE 802.4), and token ring (IEEE 803.5). For simplicity ofexposition, we focus on the case of Ethernet, which is the most popularof the three.

THE INTERNET 7

Bus Network Ring Network

Computers

Cables

Figure 2. Local Area Network

[Figure 2-2. Local Area Network.]

Specifically, Ethernet is a 1-persistent CSMA/CD (Carrier SenseMultiple Access with Collision Detection) protocol (Metcalf and Boggs,1976). Now consider the case where a computer wishes to send datato another computer in the LAN. First, the process of dividing thedata into a packet are essentially the same with the previous example.Next, the CSMA/CD protocol checks the status of the communicationchannel. If the channel is occupied with other computers, then thecomputers wait until the traffic clears. If the channel is idle, then thecomputer sends out a frame (packet) with probability 1. But there is apossibility that another computer just wishes to send data at the sametime. In that case, there will be a collusion of data. Then the computerdetects the collision, and waits a random amount of time to send thedata once again.Note that three LAN standards are incompatible. Especially, the

maximum frame length allowed in the LANS are different among allthree. Therefore, if one LAN sends a frame which is larger than themaximum acceptable frame for another LAN, the communication runsinto difficulty. Ethernet was originally developed by Xerox and Intel.The second one, token bus, was developed by GE. The third one, tokenring, was developed by IBM.They were unable to reach an agreement when the IEEE tried to

define the standard (Tanenbaum, 1999). Thus the interconnection be-tween LANs needed special devices such as bridges.

2.3. Wide Area Network. Now consider the case of interconnectingvarious local networks. In the previous case, we had two local networksof the known type, thus we can use bridges. But in this case, we have to

8 EIICHIRO KAZUMORI

Router

Router

Router

Host

Host

Host

Host

Host

Host

LAN LAN

LAN

Subnet

Figure 3. Wide Area Network.

deal with the heterogeneity of LANs. Also we need the scalability suchthat the network can deal with the increase in the number of LANsattached to the network.WAN (wide area network) is a collection of transmission facilities

used to connect computers or LANs over a wide geographical area.Examples of WAN includes PSTN (public switched telephone network),PDN (public data network), and the Internet.Physically, WAN consists of the hosts and subnets. A host is a col-

lection of computers which sends and receives data and runs programs.A subnet is a collection of routers and transmission lines. A router is adevice which receives the datagram and forwards it to the appropriatedestination.

Consider a case of a computer wishing to send data to another com-puter on a different LAN. Assume that both LANs and WAN supportTCP/IP.First, the computer prepares IP datagrams dividing the original data.

The IP software checks the destination address in the headers of thedatagram. Noticing that the destination is outside the LAN to which itbelongs, it will send the datagram to a router. A router checks the des-tination address and forwards it to the closest destination. After some

THE INTERNET 9

Network AccessPoints

Regional Network

Local Network

Backbone 1

Backbone 2

Figure 4. The Internet.

repetition of this process, all the datagrams will be at the destination,and the datagram will be reassembled as original data.An example of the WAN using TCP/IP is the Internet. Internet

consists of backbones (WAN) and the networks (regional, local, etc.)attached to the backbone. There are around 20 backbones in the U.S.These backbones have to connect to 4 NAPs (National Access Points)in San Francisco, Chicago, Washington, and New York.Note that the assumption that all of the LANs and the WAN support

TCP/IP is essential. First, the computers in a LAN can understandthe destination address. Second, the routers in the subnet also canunderstand the destination address. Thus, if any of them lacks thesupport for TCP/IP, the data communication is difficult.

2.4. Electronic Data Interchange. So far we have considered thecase of transmission of very simple data such as an email. Neverthe-less, the data used in business transactions such as invoices has morecomplicated structure inside the document. Therefore, we need to lookat the communication process of these business data. This process iscalled the electronic data intechange (EDI).An example of EDI is a buyer sending the purchase order to a seller.

The buyer produces the purchasing order. Then the buyer types thedocument in the EDI Software. The software generates the machine-readable formatted file. Then the computer sends the file accordingto the communication process discussed in the previous subsections.Then the EDI software of the sellers receives the file and translates itinto the buying order. In contrast to the email example, in EDI, thefile is be processed automatically so that the computer updates thedatabase.

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Initiating Departmentin the company

PurchasingDeparment Standarized Purchase

Order

Computer

AccountingDepartment

ReceivingDepartment

Standarized PurchaseOrder

Computer

AccountingDepartment

Shipping Department

Figure 5. Electronic Data Interchange.

Note that there are two compatibility problems in the process. First,the computer communication must transfer the file formatted by theEDI software. Since the format of the purchasing order is more com-plex than the email treated above, the compatibility process is morecomplex. Second, both companies have to have the EDI software whichcan deal with the same format. If a buyer prepares the document inANSI X12 format, and if the seller has only EDIFACT format, then,even if the computer system can transfer the X12 format file, the sellercannot process the order.

3. Coordination failures in the early history ofcomputer networking

The objective of this section is to show that there was a coordina-tion failure in computer networking before 1985. Specifically, we startfrom making theoretical arguments, and then move to their empiricalvalidation.Consider a simple game of the adoption of the network. Each com-

pany decides whether to be on the network or not. If they choose toadopt the network, they have to pay a fixed cost for the installation ofthe network equipment. The value of the network increases with thenumber of companies who are on the network. In this case, there aremultiple equilibria of the game.Specifically, there is an equilibrium of inefficiently low level of adop-

tion. The reason is that, if other companies do not adopt the network,then the best response for the company is not to adopt the network.The second argument is the network providers’ incentive to make

the protocol incompatible. Consider a game among network providers.

THE INTERNET 11

U ser-written D irec tT erm ina l P rogram s

DatanbaseA pp lication P rogram s

Q ueued andInte rac tiv e A pplication

P rogram s

B atch A pp lica tionnP rogram s

C ustom -ta i loredA ccess M ethods IM S T C A M JE SCIC S R E S

3704/05 E P 3704/05 E P 3704/05 E P 3704/05 E P

2741H ardcopyterm ina l

3277D isplay

2741H ardcopyterm inal

3780B atch

T erm inal

2741H ardcopyterm inal

Figure 6. Teleprocessing Systems.

The network provider has an option to unilaterally make the systemcompatible with the others by making the communication protocolpublic. The computer vendor’s payoff depends on the market share andthe price. The companies choose to adopt the computer system or not.Assume for simplicity that the computer vendors and the companiesmove simultaneously. In this simple setting, it is never a best responsefor the computer vendor to make the systems compatible unilaterally,because it would simply increase the competitor’s installed base. Giventhis, the companies’ adoption level will be less than the best, and thebenefit from the productivity increase will not be realized.In the rest of this section, we briefly review the development of the

computer communication technology and discuss the interoperabilityproblem with examples of the communication protocol and electronicdata interchange.

3.1. Some early commercial applications. The first demonstra-tion of interactive computer communication took place at a 1940 Amer-ican Mathematical Society meeting in New Hampshire. Bell Laborato-ries connected a teleprinter in New Hampshire to a relay computer inNew York City through a telegraph circuit.From the late 1950s, IBM started to offer computer networks. These

networks were preliminary in three aspects. First, the terminal con-troller had no programming capability. Second, it needed dedicatedlease lines. Third, it could process only one task at the same time.

An example of early commercial adoption was US Steel. US Steelstarted the joint study with IBM in 1951. In 1957, US Steel put IBM

12 EIICHIRO KAZUMORI

357 terminals on the factory floor and connected them to the centralconsole by multi-wire. The employees recorded attendance and labortransactions using pre-punched cards.A more famous example was the SABRE airline real-time reservation

processing system of American Airlines and IBM. The initial SABREsystem consisted of three parts: the Electronic Reservation ProcessingCenter in New York, the terminals in more than 50 field offices aroundthe US, and the communication network. The Electronic ReservationCenter had two IBM 7090 computer with dynamic memory allocationand multiprocessing capabilities. Also the center had large capacitymagnetic disk files as storage files. Each terminal in the field office hadan air information device, the transmission device, and the I/O type-writer. The communication network had over 10,000 miles of telephonelines and switching systems similar to the telephone network protocolsin the lower OSI layers. The document was of a very simple form suchas an email in ASCII format.For example, consider a case of a customer inWashington who wishes

to make a reservation for a flight to Chicago. The reservation desk inthe Washington field office chooses a card about Chicago, and sendsthe data and the flight number the customer wishes to the center.The center then checks whether the seat is available, and the centersends back a message to the field office about availability. After findingthe vacant seat, the center records the information such as name andinterairline information.In the 1960s, IBM offered the data communication systems to the

corporations. The system consisted of three elements: the central hostcomputer, terminal control units, and the communication hardwire. Anexample is the first general purpose 1050 Data Communication Systemin 1963. The 1050 system allowed line control, error retransmission,and provided an IBM Selectric typewriter as a printer. In 1964, IBMdeveloped the first display family 2250. After the release of IBM/360in 1964, IBM started the integration of data communication systemswith System/360. In 1967, IBM released the 2780 Remote Job Entryterminal and OS/360 Remote Job Entry (RJE) which enabled the batchterminal to submit jobs remotely to a system/360.A second example was the IBM 1062 teller terminal developed for

the First National Bank of Chicago in 1962. The terminal had thecapability of passbook feeding, printing the record of all transactionson a journal tape, and two-teller operation with separate net cash ac-cumulations.

THE INTERNET 13

U s e r - w r i t t e n D i r e c tT e rm in a l P r o g ra m s

D a t a n b a s eA p p l ic a t io n P r o g ra m s

Q u e u e d a n dIn t e r a c t iv e A p p l ic a t io n

P r o g ra m s

B a t c h A p p l ic a t io n nP r o g ra m s

I M S T C A M J E SC I C S R E S

3 7 0 4 / 0 5 N C P / V S

2 7 4 1H a r d c o p yt e r m in a l

3 2 7 7D i s p la y

2 7 4 1H a r d c o p yt e rm in a l

3 7 8 0B a t c h

T e r m in a l

V T A M

S D L C

Figure 7. The SNA Architecture.

3.2. Commercial computer networks. The computer companiesstarted to offer modern computer networking technology in the 1970s.In 1974, IBM introduced the System Network Architecture (SNA). In1976, DEC announced the DECNET.Since SNA was one of the major networks at that time, we take

SNA as an example to review the function. The 1974 SNA con-sisted of four elements: the virtual telecommunication access method(VTAM), Communication Controller and Network Control Program(NCP), Synchronous Data Link Control (SDLC), and 3270 TerminalFamily. VTAM is a control software in the application layer thatmatches the logical unit in the host to a logical unit in the termi-nal. NCP included the communication protocols that will be describedin detail later. The SDLC was a synchronous protocol in the datalink level. The 3270 terminal is the SDLC-compatible terminal con-troller. In addition, in 1975 IBM introduced an advanced communica-tion function (ACF). This function enabled interconnection among theSNA networks.

These networks were more advanced than the networks in 1960s inthree points. First, the terminals could run the application program it-self. Second, the topology of the network could be peer-to-peer, whilein 1960s the topologies of network were restricted to the star topol-ogy. Third, the process was now multi-tasking. That is, the severalprograms could be run at the same time.Here the vendors decided to choose computer networks that were

incompatible each other. The communication protocols were differentin their addressing function and data format. Therefore, it was costly,

14 EIICHIRO KAZUMORI

if not impossible, to have an interconnection among different computercommunication protocols.Consider the simplest case of sending an email from one system to

another. Suppose one system adopts TCP/IP and the other adoptsSNA. When the TCP protocol tries to set the header which determinesthe destination, the software is unable to determine its IP address sincethe other system is not on the IP system. Of course, in addition to thisaddressing problem, there can be a data format incompatibility.It is true that there existed third party gateways that would enable

the transfer of data from one network to another. Nevertheless, inaddition to the cost, the third party mail gateway often compromisedreliability. First, since the TCP/IP hosts discard the mail after itarrives to the first intermediate machines, if the intermediate gatewaysloses the mail, it will lead to message loss without informing eithersender or recipient. Second, the mail gateways could introduce delays.In addition, the transfer of the data whose format is more complicatedthan electronic mail was much harder. Quarterman and Hoskins wrote,in their 1987 Communications of ACM surveys,

[The gateways between networks with dissimilar inter-net layers] work less well than gateways at lower layers,are often less transparent, and usually have to be consid-ered by the user when sending mail across such networksboundaries. Mail is often the only service that can used.In some cases, these gateways may not be known. Inothers it may not be possible to reveal them because ofpolitical or economic considerations. (p. 941).

The standardization effort was not successful. In 1977, the Inter-national Organization for Standardization (OSI) Technical Commit-tee established Subcommittee 16 to deal with the data communicationstandards. OSI developed a series of protocols for the next 10 years.Nevertheless, due to the complexity of the protocol and the lack of

installed base, the OSI protocol did not proliferate.

3.3. Electronic data interchange standards. Since business datais more complicated than ASCII electronic mails, there has been aneed for structuring for business data. In EDI, there were standardsestablished since the 1970s. But, due to the complexity of standardsand the strategic relations among traders, the standards were not wellaccepted.

THE INTERNET 15

Interchange Control Header

Functional Control Header

Transaction Set Header

Transaction Set

Transaction Set Trailer

Functional Group Trailer

Interchange Control Header

Figure 8. ANSI X.12 Architecture.

To verify this argument empirically, we look at two cases. The firstcase is the conflict between ANSI X12 standards and EDIFACT stan-dards. The second case is the adoption of the unified standards inairline reservation systems.

3.3.1. ANSI X.12 and EDIFACT. The ANSI standardization effortwas initiated by the transportation industry. In 1968, the industryformed the Transportation Data Coordination Committee (TDCC) todevelop the messaging standards for the business transactions. TDCCstandards were developed in 1973, and have been accepted in the rail,motor, ocean, air carrier and shippers industry. Then in 1979, theANSI chartered the ASC X12 to develop a standard for intra-industryelectronic data interchange. In 1984, ANSI X12 and the TDCC formeda joint committee to consolidate the data elements between the twostandards. On the completion of the consolidation, the TDCC was as-signed to be the official gatekeeper of ANSI X.12 to assign new dataelement IDs, new data element values, etc.The ANSI X.12 structures the original data using the idea of elec-

tronic envelopes.On the other hand, the UN standards were initiated by the automo-

bile industry. In 1985-7, major automobile manufacturers in Europe(ODETTE) and the US (AIAG) developed a standard message formatrecognized EDIFACT (Electronic Data Interchange For Administra-tion, Commerce, and Transportation) as ISO 9735.

16 EIICHIRO KAZUMORI

There has been no incentive for the automobile industry to adoptANSI X.12 voluntarily. Conversely, there is no incentive for the trans-portation industry to adopt EDIFACT. If the automobile industryadopts the standard initiated by the transportation industry, then itwill lose bargaining power in tariff bargaining. As a result, automobileindustries have an incentive to develop standards by themselves. Thiswill lead to inefficiencies for the company who wants to trade with boththe transportation and automobile industries.

3.3.2. Airline Reservation System. Another example is the airline reser-vation system. In 1972, a trading organization of travel agents ap-proached Control Data to develop a commonly integrated travel agencysystem.The airline industries were concerned that the integrated system ini-

tiated by the travel agencies would result in the loss of the bargainingpower. Thus, in 1974 American Airlines proposed a joint task forceamong carriers, hardware suppliers, and the travel agencies. In 1975,United Airlines, which had the most advanced reservation system, de-cided to drop out of the project, saying that this system would serveonly as an "equalizer" among airlines. As a result, there was not acommonly used standard.Indeed, there were multiple standards in electronic data interchange.

Many industries developed specific standards, such as NRMA andVICS in Retail Industry, CIDX in Chemical industry, etc. Chorafus(1991) noted that the company operating in Europe and the UnitedStates might have to interface with more than 20 different formats.Finally, it was technically possible to deal with the compatibility

issues by using VANS (value-added networks). VANs are private net-works that offer the conversion services of different protocols. Supposea sender sends the message in X12 format to a receiver that understandsonly EDIFACT format. The sender sends the message in X12 format.Then VANs make the conversion of the format, and put the data intocentralized mailboxes in the network. The receiver goes to the mailboxand retrieves the data. However, VANs were quite expensive.

3.4. Low adoption of internetworking. The empirical data seemsto support the prediction of low adoption in electronic data interchange.In spite of the author’s best effort, a good time series data about theadoption of commercial computer network and electronic data inter-change is not readily available.In research done by the European Commission, Schemied (1999)

reported that approximately 2000 companies adopted EDI in 1980,22000 in 1990, and 25000 in 1998. Pfeiffer (1992) summarized the

THE INTERNET 17

data from trade magazines and reported that 3000 adopted EDI for1986 and 1987, 3500-6000 for 1988, 5500-9000 for 1989, 10000-14000for 1990, 10500 for 1991, and 12000 for 1992. In spite of the differencein numbers, the researchers agree that the adoption rate is inefficientlylow. Pfeiffer (1992) wrote,

Considering the many advantages regularly attributedto EDI and the fact that the basic technological prereq-uisites, namely DP systems and a telecommunicationsinfrastructure, have been available for several decadesby now, the low penetration level of EDI even by themost optimistic assessments of market research agenciesis rather intriguing. (P.112)

Moreover, Knudson, Walton, and Young (1994) reported in the Fed-eral Reserve Bulletin,

At present, neither EDI nor financial EDI was widelyused. Approximately 44,000 companies, out of millions ofbusinesses in the United States, exchange business dataelectronically. Only about 10 percent of these compa-nies also use financial EDI. Moreover, no more than fiftybanks have the capability of providing complete financialEDI services to their corporate customers.

Some research about the barrier to adoption of EDI identified incom-patibility as one of the main causes of the coordination failure. Steel(1996) reports the results of the interview study about the WorkingParties of EDI Software Producers,

The research revealed one dominant reason for this slowadoption of EDI: the great difficulty and the cost ofachieving interoperation between the application programsinvolved in the transaction using the current methods ofEDI ’ standardization ’. (p. 14)

In conclusion, business interest created the incompatibility of datacommunication protocols. This incompatibility created the switchingcosts, and this led to a sub-optimal level of electronic commerce adop-tion in the early history of electronic networking.

4. Coordination by NSFNET, 1985-90.

In this section, we study the activities of NSFNET from 1985-90.The previous network, ARPANET of the Department of Defense, wasopen only to researchers with DARPA funding. In contrast, NSFNETwas an open network, connecting universities and regional networks. In

18 EIICHIRO KAZUMORI

addition, NSFNET adopted the TCP/IP protocol suite that was widelyavailable through the Berkeley distribution of BSD UNIX. Moreover,NSFNET provided the seed funding for the regional networks such asNYSERNET in the New York area. These activities relieved the earliercoordination failures and caused the growth of networks.

4.1. ARPANET.. ARPANET was origninally created as an experi-ment in 1968 by the Department of Defense Advanced Research AgencyInformation Processing Techniques Office (ARPA-IPTO).In January 1969, the DOD awarded the contract to BBN (Bolt,

Bernanek and Newman). BBN developed the IMPs based on Honey-well 316. In December 1969, the original subnet was born connectingUCLA, UCSB, SRI, and Utah.The next significant development was TCP/IP protocol suite. Robert

Kahn and Vinton Cerf developed the idea in a 1974 paper. TheTCP/IP was intended to achieve interoperability among heterogeneoussystems with its emphasis on scalability and reliability. Specifically, IPprovided the addressing systems and TCP provided the transmissioncontrol of the packets. In 1983, the TCP/IP became the standard ofARPANET.The ARPANET has grown rapidly among universities and militaries.

In April 1971, there were 15 nodes with 23 computers. By 1983, thenumber of hosts exceeded 400.Nevertheless, access to ARPANET was restricted to the military

and to researchers with the DARPA contracts. Since the late 1970s,researchers without DARPA contracts requested access to ARPANET.But the DOD has been reluctant to grant access for security reasons.

4.2. CSNET.. In 1981, the NSF created a computer research networkcalled CSNET as a five-year project. The objective of the project wasto establish a computer network to researchers outside the ARPANET.By July 1982, researchers developed PHONENET. PHONENET wasa telephone relay that provided a low-cost mail service. By fall 1982,they established connections to GTE’s TELENET by implementingthe X.25 protocol interface for TCP/IP protocol software provided byDARPA. By June 1983, around 30 universities were on CSNET.CSNET was a predecessor of NSFNET in many aspects. First, it

emphasized openness. Private companies were allowed to connect toCSNET as long as they serve the interest of computer science researchand education. Second, it adopted TCP/IP protocol suites.Nevertheless, there were several differences. First, the size of CSNET

was much smaller than NSFNET. The budget size of CSNET was 5

THE INTERNET 19

million dollars, much smaller than that of NSFNET. Second, the targetaudience of CSNET was limited to computer science researchers.On the other hand, the clientel of NSFNET included all researchers

and educational institutions, and eventually businesses.

4.3. NSFNET. The background of this project was a perceived threatagainst the US computer industry from Japan. In 1981, MITI (Ministryof International Trade and Industry) announced the fifth-generationcomputing program for artificial intelligence and supercomputing. In1983, Japanese companies developed supercomputers which were com-parable with a top US machine Cray 1. These developments wereperceived as a threat to the superiority of the US computer industry.For example, in 1983 the US Congress held two hearings, characterizingthese developments as "New Sputnik." As a result, in 1985, the Con-gress provided 40 million dollar funding for the supercomputer centers.

4.3.1. Supercomputing Centers. The first element of NSFNET was sixsupercomputer centers. These centers were the San Diego Supercom-puter Center (SDSC), the National Center of Supercomputer Asso-ciation at University of Illinois, the Cornell National SupercomputerFacility, the Pittsburgh Supercomputer Center, the Jon von NeumannComputing Center at Princeton University, and NCAR.Consider the example of the San Diego Supercomputer Center de-

scribed by Sailing (1988). The center opened in 1985. It was equippedwith a Cray X-MP/48 and SCS40/XM mini supercomputer. 90% ofthe time available on Cray was allocated to research and education.90% of the computation was through remote-logins from outside SanDiego.Another example of research done in these supercomputing centers

was MOSAIC, the first web browser. It was developed by a team ofEric Bina and Mark Andressen in the supercomputing center at UIUC.

4.3.2. Interconnection. The second element of NSFNET was intercon-nection among existing networks. Specifically, the NSF provided thenational backbone. The national backbone is the wide area networkbased on TCP/IP connecting the supercomputing centers, existing net-works such as ARPANET, CSNET and mid-level networks. By 1986,more than 400 networks were connected to NSFNET.

4.3.3. Seeding the Local Networks. The third element of NSFNET wasfunding for regional networks. Also the NSF allowed the use of su-percomputing facilities for the regional network. In addition, the NSFoften paid the fee as an award. In total, the NSF spent 26.1 milliondollars for the fiscal year 1988-91.

20 EIICHIRO KAZUMORI

An example of such a regional network was NYSERNET, which wasformed as a non-profit organization for education and corporations inthe New York area. The founding institutions included City Uni-versity of New York, Columbia University, Cornell University, ATT,Brookhaven National Laboratory, GE, IBM, KODAK, XEROX, andthe state of New York. NYSERNET started on August 1987. In 1989,NYSERNET formed its for-profit subsidiary PSINET.There were seven regional networks by early 1988. These were BAR-

Net in San Francisco Bay Area, MIDnet in Midwest, NorhWestNet,NYSERNET in New York area, Sequintet in Texas, and WESTNETin Rocky Mountain Region.

4.4. The growth of the Internet. These policies pursued by theNSF during 1985-90 eased coordination failures. First, the backboneand regional networks created a critical mass for the adoption of thenetwork. Second, the free distribution of communication protocolsthrough BSD UNIX resolved the incompatibility problem.Indeed, the adoption of the network was enthusiastic. According to

Lotter (1992), the number of Internet hosts had increased from 213 ofAugust 81 to 159000 of July 1989. Catlett (1993) reported that therewere more than 600 industrial sites by 1991, exceeding the number ofacademic sites.

5. 5. Early Privatization of NSFNET, 1990-95.

In this section, we study the privatization process of NSFNET. Thesuccess of NSFNET created a financial and administrative overload tothe NSF. As a result, the NSF delegated the operation of NSFNETto ANS, a joint venture of IBM, MCI, and Merit. But problems aroseabout the access charge to the backbone. This led to a congressionalhearing and the revision of the NSF Act of 1950 in 1992. Then the pri-vatization scheme including NAPS (National Access Point) contributedthe creation of competitive ISP market environments.

5.1. ANS. The successful expansion of NSFNET increased the com-plexity of network operations and the cost of maintaining and expand-ing the network. Indeed, the amount of money the NSF spent for thebackbone had increased from 2.1 Million dollars in 1988 to 8.8 milliondollars in 1991. On the other hand, there were only 14 staffmembers inthe NSF for the management of NSFNET. Therefore, the NSF neededto delegate the management process.Thus, NSF agreed to subcontractthe operation of backbones to IBM, MCI, and Merit in 1990. Thesethree companies formed a non-profit corporation ANS. ANS’s mission

THE INTERNET 21

was, first, the continuation of the operation of the backbones. In ad-dition, ANS could "solicit and attach to the NSFNET backbone newusers, including commercial ones, and may connect them to new orexisting nodes on the backbone." In return, ANS could impose tariffsto the users "at least the full average cost of connection, the addedtraffic, and additional support."In reality, there were two problems. The first problem was imperfect

information. Obviously, only 14 NSF staffmembers were unable tomonitor all the details of the operation by ANS. The second problemwas that IBM and MCI had their corporate interests. In particular,IBM had developed its own proprietary data communication protocolSNA. The commercial access to the backbone was the main issue.In early days of NSFNET, commercial traffic was formally prohibited

but actually admitted to the network. On one hand, AUP (AcceptableUse Policy) formally prohibited the commercial use. Specifically, items(10) and (11) state the following:

Unacceptable uses: (10) Uses for for-profit activities (con-sulting for pay, sales for administrations of campus stores,sale of tickets to sports events, and so on.) Or use by for-profit institution covered by the general principle or as aspecifically accepted use... (11) Extensive use for privateor personal use.

On the other hand, the degree of enforcement of this policy was de-batable. First, with only 14 staffmembers, it was impossible to checkall the traffic. Second, there was a legal problem about whether NSFhad the authority to look into the private traffic and enforce the sanc-tion. Indeed, in 1992 congressional hearing, a NSF official testified asfollows:

Because it (AUP) is retroactive, because we do not po-lice the network, because we don’t look over anybody’sshoulder and read their mail, and of course, it is impos-sible to tell what - if it is a conspiracy to misuse thenetwork, it will go unnoticed.

In May 1991, ANS had obtained the authority to move commercialtraffic across the NSF-sponsored network. ANS formed a pro-profitsubsidiary CO+RE. CO+RE was the only company which could ap-prove the commercial traffic over NSFNET. This position was furtheremphasized by the fact that about 35% of all network sites were reach-able only via the transit of the NSFNET backbones.ANS set up a contract for regional networks based on this position.

ANS provided three options for the contract. The first option was

22 EIICHIRO KAZUMORI

a connectivity agreement. A connectivity agreement just allows thecommercial traffic from ANS to enter into the network. The secondoption was a gateway agreement. This agreement enables the networkto send commercial traffic to the ANS backbone. In return, the networkwill pay the ANS fees based on the amount of traffic. The fee wasestimated to be around 2000 dollars per commercial site. The thirdoption was a cooperative agreement. In this agreement, the networkdoes not have to pay the connectivity fees. In return, ANS will be ableto directly market with commercial sites in the network.An example of a company with commercial traffic is Dialog. Dia-

log entered into a contract with ANS for the commercial use of thebackbone in 1991. ANS established the routing controls so that the re-gional networks which were not in agreement with ANS were not ableto receive the traffic from Dialog.

5.2. Emergence of commercial ISPs and the competition withANS.. A commercial ISP is an organization that connects businessor residential customers to the Internet. Usually ISPs provide threetypes of services. For example, an ISP provides access services such asdial-up or DSL (digital-subscriber line) services. In addition, they mayoffer the transit or backbone type of connectivity. Moreover, ISP canprovide value-added service through managed web services or firewalls.The first ISPs were often the spin-offs of the regional networks founded

in late 80s through the seed funding from the NSF. Since NSF’s AUPdoes not involve regional networks, they were free to start commercialcompanies. For example, PSINET was founded through venture fund-ing as a spin-off from NYSERNET. By 1990, PSINET and UUNEThad the coast-to-coast backbones. But most of the ISPs were regionaland small-scale. Thus they needed to interconnect to other networksto carry the traffic.In February 1991, PSINET, UUNET and CERFnet of California

formed CIX (Commercial Internet Exchange). The objective of CIXwas to interconnect the networks so that they would freely pass un-meterted commercial traffic to each other. The participation fee was10,000 dollars for one time and there was no additional fee.Thus there was competition between ANS and CIX the commercial

traffic. According to the congressional testimony by Mitch Kapor,

ANS began competing for commercial and non-commercialcustomers by telling prospective customers that they could"connect directly to the backbone without using the re-gional networks, and that they should connect to ANS

THE INTERNET 23

since" at any time, ANS could disconnect PSI or any ofthe Regional which had not signed the ANS agreements.

In addition, some testimony said that some ISPs stopped the invest-ment in faster Tl to T3 technologies due to the uncertainty about thestability of connection.

5.3. Privatization. In March 1992, the House Subcommittee on Sci-ence held a hearing about the management of NSFNET. CongressmanRick Boucher chaired the hearing. The witnesses included membersfrom the NSF, Merit, CIX, and PSI. There were three issues. The firstpoint was AUP. The second issue was the unfair competition amongNAP and CIX. The third issue was the recontracting of the NSF back-bones.The direct result of the congressional hearing was an amendment of

the NSF Act of 1950. In this amendment, the NSF was authorized toenhance an unrestricted use of the network if this increases the valueof research and education activities. Specifically, the amendment says,

(g) In carrying out subsection (a)(4), the Foundation isauthorized to foster and support the development andthe use of computer networks which may be used sub-stantially for purposes in addition to research and edu-cation in the sciences and engineering, if the additionaluses will tend to increase the overall capabilities of thenetworks to support such research and education activi-ties.

Furthermore, the NSF started the substantial privatization processafter this hearing. The first step was the interconnection between ANSand CIX. In June 1992, ANS agreed to the interconnection with CIXon an experimental basis. Later, ANS joined CIX.The second step was the recontracting and the establishment of

NAP’s (national access points).As a result, when NSFNET was reverted to the academic network

in 1995, it was not difficult for the private ISP markets to take over,and the smooth transition to a private industry-oriented network wasrealized.

6. Conclusion

This paper presented an institutional analysis of the developmentof the Internet in the United States, focusing on the role of NSFNETfrom 1985 to 95. We proposed and verified the hypothesis that earlybureaucratic coordination followed by early privatization was effective

24 EIICHIRO KAZUMORI

in easing an earlier coordination failure and avoiding later potentialregulatory inertia. This case study sheds lights on the role of thegovernment in economic developments.

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