DRI-281 for week of 2-24-13: Our Telecommunications Marketplace: The Rest of the Story

An Access Advertising EconBrief:

Our Telecommunications Marketplace: The Rest of the Story

Last week’s EconBrief told the tale of the man who, with reasoned premeditation, set out to release the telecommunications marketplace from the thrall of natural monopoly. This week we counter with what the late Paul Harvey might have called “the rest of the story” – the complement to the policy revolution wrought by Tom Whitehead in the White House Office of Telecommunications Policy.

This is a different story altogether. The actions of the Federal Communications Commission (FCC) and the Department of Justice (DOJ) were triggered by the chance decision of one man. That man was not an economist or a free-market ideologue. He was a lawyer and bureaucrat motivated by helplessness and disgust with his task of regulating the Bell system. He sought only to inflict a pinprick – but ended up helping to topple the world’s largest corporation from its monopoly throne.

The key elements of the story were told by economic historian Peter Temin in his short essay, “The Primrose Path,” in Second Thoughts: Myths and Morals of U.S. Economic History, edited by Donald N. McCloskey.

Enter Bernie Strassburg

Bernie Strassburg was a lawyer who headed the FCC’s Common Carrier Bureau. He was charged with regulating telephone and telegraph companies; e.g., he rode regulatory herd on AT&T and Western Union.

In the early 1960s, AT&T was the world’s largest corporation. Federal law gave them a virtual monopoly on American telephone service, both at the local level and for long-distance service. But the monopoly also extended to telephone equipment as well; it as illegal to use any equipment not manufactured by Bell. Thus, the Bell system was vertically integrated.

Regulating them was like wrestling an octopus. Each of the Bell regional companies was regulated by the public-utility commissions (PUCs) within its service area. PUCs conducted hearings to determine the allowable “fair rate of return” on the utility’s rate base. This formed the basis for the rates charged by the company.

The word “rates” applies literally. Instead of charging one universal rate to all users, the Bells charged differential rates to different classes of users. Residential users got preferential low rates, thanks to the doctrine of “universal service.” Telephone service was deemed a necessity to health and safety reasons and the low rates were ostensibly necessary to make it affordable to low-income residents. Business users got special rates – special high rates, that is. After all, businesses could apparently afford to provide all kinds of non-salary benefits for employees, such as health insurance, pensions, retirement accounts, etc. Why not make businesses pay high rates for telephone service and use the proceeds to subsidize residential service?

Of course, economists know why not. This is precisely analogous to a tax on business, and no business ever paid a tax. Instead, the tax – or, in this case, the high charges for telephone use – are borne in the short run by owners and employees of firms driven out of business by the higher costs, as well as by consumers of goods produced using telephone services as an input. In the long run, all costs are borne by suppliers of inputs and/or consumers. In this case, that means consumers of goods that use telephone services in their production and suppliers of inputs to those industries. Too few of those goods are produced and too many resources are devoted to providing telephone services to residential consumers. Although residential consumers pay a lower prices for telephone services – at least temporarily – their real incomes are almost surely lower thanks to the smaller quantity of other goods and services they consume.

A crowning irony of the politically sacrosanct doctrine of universal service is that the penetration of telephone service never reached the levels reached by television. Apparently telephone service wasn’t as necessary as television service, no matter what regulators claimed.

Instead of high nominal profits, public-utility owners earned the equivalent of lower nominal profits at virtually zero risk. Utility managers earned high salaries, worked in plush offices and oversaw huge staffs. Utility executives substituted easy living and a quiet life for the go-go, big-profit lifestyle of corporate America. Well-off elderly Americans held AT&T and Bell regional stocks in their portfolios for risk-free high returns. And this cushy deal was safeguarded by Bell’s political activities. State and local rate regulation attracted Bell lobbyists like locusts to the legislative harvest. Lobbying costs were paid by ratepayers.

The Bell system’s equipment monopoly was just as stifling as its monopoly on phone service. Bell’s monopoly on phone service was reinforced by a prohibition on the conjunction of Bell and non-Bell equipment. Thus, use of competing answering machines, modems and telephones was barred if it involved interaction with Bell facilities. In the mid-1950s, DOJ filed an antitrust lawsuit against AT&T challenging the integrated company’s refusal to allow “private communication” on its network.

Bell’s response was that it was willing to provide such items for its customers. Indeed it was – at a price. Bell’s AT&T Long Lines company also provided long-distance service – at high rates that subsidized the system’s artificially low residential customer rates. It provided data transmission service to business – at prices so high that some businesses even incurred the expense of setting up their own two-way private networks between key locations. The issue wasn’t so much provision of service as its terms.

The Paradox of Natural Monopoly Regulation

The idea behind natural monopoly is that one single firm is the most efficient supplier for the entire market. Even if competition is allowed, the process will inevitably culminate in the victory of a single firm, and that firm will then proceed to establish the price and output of a pure monopolist. Because that price is so much higher and the rate of output so much less than would be “chosen” (in the aggregate) by a competitive industry of firms, government regulation intervenes to seek a preferable compromise. The efficiency of single-firm production is enjoyed, while the price and output outcomes of pure monopoly are moderated – not to the degree attained under competitive conditions, but enough to reward the firm’s owners with only a “normal profit.” That rate of profit is only just sufficient to attract the capital needed by the firm.

This compromise seemed superficially attractive. It avoided the disadvantages of the other popular public-utility model, adopted in Europe and Canada. Equating the public-utility price to its marginal cost would approximate the price and output result under competition. But public utilities often exhibit decreasing average costs of production for technological reasons such as the famous 2/3 Rule. When an average magnitude is falling, that means its corresponding marginal value is less than the average; the marginal is pulling the average down. If price is set equal to marginal cost, it must be less than average cost under decreasing cost conditions of production. When price is less than average cost, the firm is losing money. The European/Canadian model is feasible only when accompanied by large public subsidies to the public-utility firm. Meanwhile, all the same difficulties and expense of conducting rate cases and calculating the utility’s costs are still present.

In actual practice, the case of the Bell system exposed the gaping flaws in the U.S. version of natural monopoly regulation – indeed, in the very concept of natural monopoly itself. If regulation had established a single price for all users, it might have remained viable. But this would have exposed the true costs of providing phone service to the American public. It would have allowed them to judge whether the benefits of having a single integrated firm provide service to everybody were worth the drawbacks of excluding competitors and innovation from the market.

Government was not willing to tell the public the truth when a politically irresistible lie was within their grasp. By setting residential-consumer rates artificially low, it could pose as the public’s benefactor, the savior who rescued them from the clutches of the evil monopoly. Of course, regulators would then have to make good on their promise to the public utility’s owners by making up the lost revenue somewhere else. They did this by allowing the company to charge draconian prices to business and long-distance users. This won the votes of dreamers who liked to fantasize that non-human entities called “businesses” could pay taxes and lift the burden of high prices from ordinary people.

It is true that the public avoided the obvious ill effects of unregulated pure monopoly – a single high price, reduced output and above-normal profits. But all these same effects were realized in hidden form – monopoly prices paid by businesses and long-distance users, reduced output of private communications and goods using telephone services and risk-free profits and lifestyles enjoyed by public-utility owners, managers and employees.

While an unregulated monopolist doesn’t have to worry about regulation, he does have to worry about entry of competing firms. Of course, the theory of natural monopoly claims that firms won’t want to enter once the natural monopoly is attained. But in that case, why did the federal government constantly fend off the advances of firms wanting to compete with AT&T? This highlights the worst aspect of natural monopoly regulation – the strangling of incipient competition in its crib.

And this is where Bernie Strassburg came in.

The Pinprick

The 1956 DOJ lawsuit sought to restructure the Bell system along European lines by forcing divestiture of the Bell Operating Companies (the regional Bells) and equipment divisions (Western Electric and Bell Labs). Bell insisted on maintaining its integrated system. The Eisenhower administration asked the FCC if it could regulate the integrated system.

Speaking in his capacity as head of the Common Carrier Division, Strassburg drafted a memo in which he maintained that the FCC had the authority to regulate the entire Bell system but lacked the resources and expertise to do the job. Strassburg was reflecting on the reality of natural monopoly regulation as we have described it. But his bosses at FCC, thinking only of their own welfare, deleted the second part of his reply and submitted this edited memo to the Administration. Consequently, the Bell system’s position was accepted on the presumption that the federal government’s regulatory authority would suffice to protect the public welfare.

Now Strassburg was in a fix. He had been told to herd an unruly rogue elephant without being given as much as a stick to help with the job. In desperation, he cast about for any means of prodding the beast towards lowering costs (hence, prices) and accepting competition. First, he used the imminence of computer technology as an excuse to force acceptance of private devices as adjuncts to Bell technology. He was aided by the FCC’s decision in the Carterfone case, which forbade Bell’s prohibition of outside equipment on private lines.

Next, Strassburg considered the application of a tiny company with only 100 employees. The company was named MCI. It wanted to lease its microwave-tower facilities stretching from St. Louis to Chicago to private businesses for use in voice and date transmission via radio waves. Companies that could not afford to build their own internal network could lease MCI’s facilities more cheaply than they could purchase Bell’s expensive package of business services.

Microwave technology had been around since World War II. The FCC had already decided in 1959 that the Bell system did not own airwave rights to microwave radio transmissions. The question was: Could MCI meet the government standard of “convenience and necessity” required to get permission to enter the market?

There were countless businesses tired of paying through the nose for AT&T’s business service, even on this one route, so lining up prospective customers to testify in their behalf was easy. But MCI had to show a “need” for their service by proving that they were more efficient than Bell. It wasn’t enough that they could offer their customers a lower price – the government didn’t recognize that as sufficiently valuable to justify allowing competition.

MCI claimed that their microwave technology was more efficient than AT&T’s landline technology. AT&T countered that MCI was simply “skimming the cream” of AT&T’s business customers, who were paying AT&T’s monopoly price, without having to assume the burden of providing residential service to AT&T’s local customers. In a sense, AT&T was right, because the technological differences did not represent large differences in cost. But in the substantive economic sense, MCI was lined up on the side of economic efficiency and consumer welfare. MCI was breaking up the AT&T pattern of cross-subsidy between business and residential consumers, which was creating concealed monopoly inefficiencies and harming consumers on net balance.

Strassburg has no illusions that MCI would be able to compete effectively with powerful AT&T. As Peter Temin noted, all Strassburg wanted was a pin to prick the rogue elephant with, something to wake it up to the changing technological realities of the unfolding new age. So he supported MCI’s petition to operate. AT&T’s appeal was denied.

MCI Unleashed

In 1969, MCI was allowed into the market for microwave voice and date transmission. Its new CEO, venture capitalist William McGowan, didn’t waste a second. He knew that there were dozens of routes whose profit opportunities mimicked those of the St. Louis-Chicago corridor. So he created over 2000 MCI-affiliate companies whose applications flooded the FCC.

Bernie Strassburg abandoned all pretense of considering each individual application. In 1971, the FCC issued a general rulemaking approving microwave facilities that met general criteria for service.

In order to serve hundreds of different customers, MCI couldn’t contemplate building separate connection facilities with each one. Instead, MCI applied to interconnect with Bell’s facilities. By this time, AT&T could see the handwriting on the wall and knew that MCI was a genuine competitive threat. It refused MCI’s interconnection requests. MCI filed an antitrust action against AT&T in 1974 alongside the DOJ’s celebrated suit.

Also in 1974, MCI offered its own package of switched long-distance service. This marked a competitive milestone. In five years, MCI had gone from a piddling 100-employee firm with no revenue and one private-service route to a full-fledged competitor of the mighty AT&T.

This was too much even for the FCC, which opposed MCI’s petition to offer long-distance service. But the genie was out of the bottle now. Bernie Strassburg has unleashed the forces of competition and nothing could pen them back up again. By 1981, AT&T had to give up ownership of the Bell Operating Companies in exchange for the right to retain vertical integrated status. The Bell System as such was gone. The monopoly was broken.

During its corporate career, MCI developed important innovations. The company applied for the first common-carrier satellite license when the White House OTP’s “Open Skies” policy went into effect. It was the first telecommunications firm to install single-mode fiber-optic cable, which is the industry standard today. In the early 1980s, MCI developed an early version of electronic mail. And in the mid-80s, MCI worked with several universities to establish high-speed telecommunications links between their computer systems – a forerunner of the Internet.

The Rest of the Story

Bernie Strassburg’s story complements that of Tom Whitehead. The birth of our modern telecommunications marketplace was a miracle. Tom Whitehead intended the substitution of competition for monopoly but it was miraculous that he ever ascended to a position of sufficient power to effect it. Bernie Strassburg intended no such outcome as the birth of competitive telecommunications; all he ever wanted was to get more regulatory leverage over the Bell System. He never questioned the bona fides of the natural monopoly argument nor did he hope that MCI would ever compete successfully with AT&T.

The fact we needed a miracle to give us the manifest blessings of cell phones, digital technology, I phones, smart phones, cable telephony and streaming Internet is profoundly disturbing. In a competitive environment, the fact that any particular firm succeeds as Microsoft or Apple has may be amazing but the fact that some firm does is no miracle at all; it is what we justifiably expect. But regulation gave us plodding, inefficient, complacent monopoly for decades; the fact that competition eventually triumphed over it was a miraculous accident.

Nor did it have to happen this way. The well-known industrial organization economist Harold Demsetz pointed out some four decades ago that regulated monopoly is not natural, necessary or inevitable. Even if there is no competition in the market, firms can still compete for the market. That is, we could have put up the right to operate as a monopolist in a public-utility market for competitive bids. In effect, firms could bid by committing to the price and quantity targets they would subsequently meet, with the best bid winning the contract. In this way, the bidding process itself would be the check on monopoly power. If there were enough bidders, we would expect the outcome to approximate that of a competitive process.

In his book Capitalism and Freedom, Milton Friedman pondered the possibilities under so-called “natural monopoly” conditions. He concluded that unregulated monopoly is preferable to regulated monopoly. The history of public-utility regulation vindicates Friedman’s position. The defects of hidden monopoly under regulation outweigh those of straightforward monopoly.

Today, the concept of natural monopoly is laughable when applied to the telecommunications marketplace because technological innovation proceeds so quickly that it offsets any temporary effects of monopoly power. Today’s “monopolist” is tomorrow’s has-been; a downward-sloping cost curve cannot compete with a downward-shifting cost curve.

Instead of relying on regulation to produce these miracles, it is long past time to reform it or eliminate it altogether.

DRI-293 for week of 2-17-13: The Man Who Created Today’s Telecommunications Marketplace

An Access Advertising EconBrief:

The Man Who Created Today’s Telecommunications Marketplace

Today we live in a world enveloped by telecommunications. I-phones and Smart-phones provide not only voice communications but data and Internet transmission as well. Cell phones are ubiquitous. Television stations number in the hundreds; their signals are received by consumers in direct broadcast, cable and satellite transmission form. Both radio and TV broadcasts can be streamed over the Internet. The Internet itself is accessible not only using a desktop computer but also via laptops, Wi-Fi and mobile devices.

For anyone below the age of forty, it strains the imagination to envision a world without this all-encompassing marketplace. Yet older inhabitants of the planet can recall a starkly primitive telecommunications habitat. In the United States – the most technologically advanced nation on Earth – there was one telephone company for almost all residents in 1970. There was one satellite transmission provider. In the wildly competitive corner of telecommunications – broadcast television – there were three fiercely competing networks.

How did we get from there to here in forty short years? And can we entertain an alternate scenario in which we might not have made the journey at all? The answers to these questions are chilling, for they open up the possibility that were it not for the efforts of one man, the great revolution in telecommunications might not have happened.

The man who created the telecommunications marketplace of today was Clay “Tom” Whitehead. The unfamiliarity of that name is an index of why we should study the unfolding of competition in the market for telecommunications. Before we introduce the leading character in that drama, we first set the scene by describing the terrain of the market in 1970 – and what shaped it.

The Economic Doctrine of Natural Monopoly

In 1970, American Telephone and Telegraph – the corporate descendant of the Bell Telephone Company founded by Alexander Graham Bell – was the monopoly telephone service provider for virtually all of America. The rationale for this arrangement was provided by the doctrine of natural monopoly.

A natural monopoly was said to exist when a single firm was the most efficient supplier for the entire market. This was caused by the unique cost structure of that market, in which the average cost of production decreased as output increased. It is vital to visualize this as a static condition, not a dynamic one; it is not dependent on a succession of technological innovations of the sort for which Bell’s scientists were renowned. If Bell Labs had never developed a single invention, in other words, the company’s status as a natural monopoly would not have changed.

If decreasing average cost was not due to innovation, what did cause it? The most plausible explanation came from engineering. The 2/3 Rule related the productivity of transmission through a pipe or transportation via a container to its cost. But since its cost increased as the square of surface area while its productivity or throughput increased as the cube of its volume, the average cost or ratio of total cost to total output continually fell as output increased because productivity (in the denominator) increased faster than cost (in the numerator).

Continually falling average cost meant that one firm could constantly lower its price while producing ever more output, while still covering all its costs. This would enable it to underprice and force out any and all competitors. Since monopoly was the eventual fate of the industry anyway, better to relax and enjoy it by declaring a monopolist while striving to mitigate the monopoly outcome.

In America, the mitigation was accomplished by profit regulation. The natural monopoly firm was allowed to earn a “normal” rate of return, sufficient to attract capital to the industry, but no higher. That normal rate of profit was identified by the public utility commission (PUC) based on hearings at which the company, regulators and various interest groups (notably regulators supposedly representing consumers) testified.

When outlined in textbooks and classrooms, this concept sounded surprisingly reasonable. When put into practice, though, it was a mess.

Perhaps the worst feature of PUC-regulation of so-called natural monopoly was the increasing chumminess between commissions and the monopoly firms they oversaw. This sounds like an accusation of collusion, but in reality is was the inevitable by-product of the system. Commissions lacked the technical expertise to regulate a high-tech business. While they possessed both the right and the ability to hire consultants to advise them, trouble and expense relegated this to rate-case hearings at which the profits and rates charged by the company were reviewed. On a day-to-day basis, the commission was forced to cooperate with and rely on the company’s employees to guarantee that the utility’s customers were served.

After all, the firm was a genuine, honest-to-goodness monopoly – not a phony, pseudo-monopoly like the oil companies, which faced scads of competition and any one of whose customers had lots of competitive alternatives to turn to. The oil companies were monopolies only for purposes of political theater, when politicians needed a scapegoat for their foolish energy policies. But if a public utility were threatened with insolvency or operational failure, then the lights might go out or the phones go dead for an entire city, metro area or region. So the PUC was regulating and utility and protecting it at the same time.

Regulation was probably an impossible task anyway, but this ambiguity made things hopeless. The result was that PUCs erred on the side of excessive rates of return and compliance with company wishes. Since high profits were out of the question anyway, public-utility executives took their “excess profits” in the form of perquisites and a quiet life, free from the stresses and strains of ordinary business. Public utilities became noted for lavish facilities, huge administrative budgets and large staffs – in the vernacular of the industry, this was called “gold-plating the rate base.” (The rate base was the agreed-upon list of expenses and investment the company was allowed to recover in rates charged to customers and upon which its rate of return was earned.)

Ordinary businesses feel constant pressure to hold down costs in order to maximize profit; cost-minimization is what helps insure that scarce economic resources are used efficiently to produce output. But public utilities were assured of their profit and coddled by regulators; thus, they faced no pressure to reduce costs or innovate. Indeed, the reverse was true – a cost innovation would theoretically call for new rate hearings to reduce the utility’s rates, since otherwise it would exceed its regulatory allowance of profit. Economists were so fed up with the sluggish pace of technological progress among public utilities in general, and the Bell system in particular, that most viewed the phenomenon of “regulatory lag” as a good thing. It was worth it, they reasoned, for the utility’s profits to exceed its limit in the short run as an inducement to effect cost reductions that would achieve long-run efficiency.

It would seem that PUCs would have faced public criticism for failure to hold down public-utility profits, since that was their primary raison d’être. Commissions sought to inoculate themselves from this criticism by a policy of offering artificially low prices to residential customers of public utilities. Since they had to raise enough total revenue to meet all utility costs plus an allowance for a fat profit, this subsidy to residential customers had to be recouped somewhere. In practice, it was regained by socking business users with onerous rates. The Bell phone companies, for example, charged notoriously high rates to business users of telephone service.

Commissions trotted out a legal rationale for this policy of price discrimination in favor of residential users and against business users. The policy furthered the goal of universal service, claimed commissioners proudly. Because public-utility products were goods like telephone service, electric power and gas service, commissions could plausibly depict them as necessary to public health and safety. Consequently, they justified subsidies to residential users by maintaining the necessity of assuring service to all, regardless of income, on the basis of need.

Of course, the economic logic behind the policy of universal service was non-existent. High rates levied on businesses were not paid by non-human entities called “businesses.” No business ever paid anything in the true economic sense because payment implies a sacrifice of alternative consumption and the utility or happiness delivered by it. Since a business cannot experience happiness – or lose it – a business cannot pay for anything. Those high business rates for phone service, for example, were paid in the long run by consumers of the business’s output in the form of higher prices and by suppliers of inputs to the business in the form of lower remuneration. But to the extent that the public were deceived by the rhetoric of the commission, they may have approved the wasteful doctrine of universal service. This is ironic, for the Bell system never succeeded in increasing the percentage of household subscriptions to phone service to the level of the percentage of households owning a television set. So much for the absolute necessity of telephone ownership!

Meanwhile, public utilities became public menaces when they spotted businesses threatening their turf. Cellular telephone technology was technically feasible as long ago as 1946 (!), but the Bell companies weren’t interested in developing it because they already had a highly profitable and completely secure fiefdom based on landline technology. And they weren’t about to stand idly by while other businesses moved in on their markets! Consequently, applicants for licenses to operate mobile phone businesses were either denied or hamstrung by red tape.

In 1956, the Justice Department was sufficiently fed up with Bell’s antics to launch an antitrust suit against the Bell system. In a sense, this was inherently contradictory since government had granted the monopolies under which the Bell companies operated. But Justice accurately realized that something had to be done to break up the cozy arrangement between Bell and the state and local politicians whose regulation was in fact serving as the barrier to competition in products ancillary to Bell’s landline phone service. It is one measure of the political influence wielded by the Bell empire that this lawsuit proved abortive and was dropped without result.

Another indicator of Bell’s power was the fact that the Bell companies annually issued more debt than did the federal government itself. When the federal antitrust action was revived in 1974, then-Secretary of State George Schultz (formerly a well-known labor economist at the free-market oriented University of Chicago) reminded prosecutors of this fact and advised that the antitrust suit be quashed for fear of “roiling the bond markets” prior to an upcoming bond issue by the U.S. Treasury. This advisory outraged a relatively obscure White House official at the Office of Technology Policy.

Tom Whitehead and the “Open Skies” Policy

In 1970, Clay T. “Tom” Whitehead was a young (32) graduate engineer whose life had taken a detour when he was introduced to economics. He followed up his Master’s in electrical engineering at MIT with a PhD in economics there, studying under noted scholar, theorist and consultant Paul MacEvoy. When the Nixon administration inaugurated the position of White House Office of Telecommunications Policy, Whitehead’s academic credentials and connection to MacEvoy earned him the post of Director. President Nixon viewed the subject of economics with ill-concealed disdain; his aides envisioned the job as a way of grabbing countervailing policymaking power away from the permanent regulatory bureaucracy that controlled the federal government and was dominated by Democrat appointees. Little did they know what kind of policymaker they were getting.

The moon landing in 1969 had achieved the objective of NASA’s space program, which was left with no immediate goal in sight. The Vietnam War had become a fiscal burden as well as a political one, and there was talk of enlisting the private sector to carry some of the financial freight by sponsoring a communications satellite. Up to that point, the satellite program (COMSAT) had been a de facto joint creature of the federal government and AT&T. NASA produced the satellites, the best-known being Telstar. AT&T owned a plurality of the stock shares and seats on the board of directors.

The chairman of the Federal Communications Commission (FCC), a Republican, drafted a proposal for a fully privatized company. It was to be a joint monopoly to be shared by NBC, ABC, CBS, RCA, GTE (a Bell company) and AT&T. The presumption was that satellite communications was a natural monopoly like all other forms of communications – television and radio networks, telephone and telegraph. There was no point in promoting a competitive process that was bound to culminate in a monopoly.

Tom Whitehead begged to differ. He put forward a radically different proposal called the “Open Skies” policy. There was plenty of room in space for many satellites owned by many different private companies, each serving their own interests and customers. There was plenty of bandwidth available for satellites utilize in receiving signals and transmitting them back to Earth. All that was necessary was to adjust orbits and frequencies to preclude collisions and confusion – something that all parties had an interest in doing.

Practically everybody thought Whitehead was crazy. The ones who didn’t doubt him feared him because he threatened their economic or political predominance. But he had the backing of the White House, not for ideological reasons but because he opposed the Establishment, which hated Richard Nixon. And he won his point.

One by one, private firms began sending up communications satellites into space. First came Western Union in 1974. Then came RCA in 1975, followed by Hughes and GTE. The first half-dozen were the pioneers. Eventually, the trickle became a deluge. And the modern age of telecommunications was born.

Privatization of satellite communications also stimulated competition in, and with, cable television. Cable TV had previously been strictly a local phenomenon, tied to AT&T by the need to lease coaxial cable facilities and rights of way. Whitehead approved FCC 1972 policy proposing to loosen federal regulations on cable. In 1974, he chaired a committee whose report advocated federal deregulation of cable. This freed the industry to lease and own satellites and take its product national. Satellite communications allowed competing cable providers uplink popular local and regional stations’ programming to satellite for national distribution. Later, satellite TV emerged as a leading competitor to cable TV, providing more channels, better reception and fewer problems.

More recently, satellite radio and TV have developed their own competitive niches. Satellites have become the transmission media of choice for telecommunications, establishing a transmission position of advantage from which signals could be sent throughout the planet. This revolution was the brainchild of Tom Whitehead.

Tom Whitehead and the Breakup of AT&T

Tom Whitehead did not initiate the antitrust suit against AT&T, nor was he directly involved in prosecuting it. But he was a powerful influence behind it nonetheless.

His staff at OTP had independently reached the conclusion that the political power and economic inertia of the Bell system formed an insuperable obstacle to competition in telecommunications. When he urged them to approach the Department of Justice about reactivating its 1956 suit against Bell, they learned that DOJ was moving in that direction already.

Had the White House opposed this initiative, it would have stalled out like its predecessor. The Department of Defense claimed that the lawsuit was a threat to national security because the Bell system was a vital cog in the national defense. (Among other things, AT&T worked closely with DOD, the Pentagon and the FBI on civil defense, counter-espionage and domestic military exercises.) As noted above, AT&T even wielded financial clout in government circles because its capital-intensive production methods made it even more heavily reliant on debt finance than the federal government itself.

But Whitehead was adamantly in favor of the action. The American public complained about the absurdity of fixing a phone system that wasn’t broke and compared the suit to a parallel action against IBM. In fact, the two had nothing in common, since IBM wasn’t a monopoly while AT&T was a monopoly in the old-time, classical sense – it was not only a single seller of a good with no close substitutes, but entry into its market was legally barred by the government itself.

The regional Bell companies resisted the breakup tenaciously and still to this day continue to fight harder against competition than they do commercially against their competitive rivals. After all, they were created as creatures of regulation, not competition, and don’t really know how to behave in a competitive market.

The result speaks for itself. Today, Americans have decisively rejected landline telephone service and embraced the new world of wireless and digitized telecommunications. They can obtain phone service via cell phones or more sophisticated mobile devices that perform multiple functions. They can combine phone service with data processing functions over the Internet. The last vestiges of the old monopoly remain standing alongside the dying Post Office in the form of mandatory service provided to remote and rural areas. Today, even the staunchest defenders of regulation and the old status quo cannot deny that Whitehead was the visionary and that they were the reactionaries.

Whitehead’s Subsequent Career

After leaving OTP in 1974, Tom Whitehead went first to a subdivision of Hughes Communications, where he started a private cable division. He thus became instrumental in what later became the development of satellite TV. Then he fomented his next revolution by moving to Luxembourg (!), where he started SES Astra, a satellite company that pioneering private television broadcasting in Europe. Before Whitehead, Europe had no private television broadcasters; they were all state-owned.

Luxembourg was chosen because its miniscule size allowed Whitehead and company to chainsaw their way through its government bureaucracy relatively quickly. The nature of their opposition can be gauged by the fact that they faced their first lawsuit within 20 minutes of receiving their incorporation papers. Today, the company Whitehead founded is the world’s second-largest satellite provider, riding herd on more than 50 satellites that serve over 120 million customers.

After retiring, Whitehead taught at GeorgeMasonUniversity where he hosted the world’s leading figures in telecommunications at his seminar. He died in 2008. This year, the Library of Congress received his papers. The American Enterprise Institute commemorated the occasion by organizing a symposium of his friends and co-workers to highlight his role in shaping the world we inhabit.

The Economic Significance of Tom Whitehead

Tom Whitehead’s life starkly defines the importance of individuals to history and human welfare. Only a tiny handful of other human beings on the planet might have occupied his position and achieved the outcomes he did. And without those outcomes, the world would be a vastly different – and far worse – place.

Tom Whitehead was fought tooth and claw by the forces of government regulation. (The historical chain of coincidence that lined up DOJ against AT&T will be the subject of a future EconBrief.) This illustrates the fact that government regulation of business is not a useful supplement to marketplace competition, but rather an inferior substitute for it. The purported aims of regulators are in fact precisely the outcomes toward which competitive markets gravitate. If regulators knew better than businesspeople and consumers how to produce, sell and select appropriate numbers and kinds of goods and services, they would work in the private sector rather than in government. Their position in government places them poorly to run companies or industries, or to impose their will on consumers. In this case, if regulators had their way, we would still occupy the telecommunications equivalent of the Stone Age.

Whitehead’s life illustrated the difference between technological progress and economic progress. Communications satellites became technically possible in the late 1950s; cell phones in the mid-1940s; cable TV in the 1930s. But these did not become economically feasible until the 1970s. And economic feasibility, not technical or engineering feasibility, determines value to humanity.

Economic feasibility requires demand – a use must be found that delivers value to consumers. It requires supply – the technically-feasible product or process must be produced and sold at a sacrifice of alternative output that consumers can accept. Last, but not to be overlooked, the technically feasible product or process must be politically tolerated. Incredible as it might seem, this last hurdle is often the highest.

Tom Whitehead played a direct role in meeting two of these requirements for telecommunications and indirectly allowed the third to be met. He created the telecommunications market we enjoy today as surely as did Edison, Tesla and the technological pioneers of the past.

His name should not languish in obscurity.