April 1997 | Volume 48, Issue 2
When MCI, the company that broke the monopoly that AT&T had on long-distance telephony in the United States and Canada, was sold recently, it went for $22 billion. That’s not bad for an operation that less than three decades ago was having trouble borrowing thirty-five thousand dollars. It is perhaps the greatest example of creative destruction in the modern history of capitalism.
Joseph Schumpeter, the great philosopher of capitalism, coined the phrase creative destruction . He was referring to the never-ending restructuring that takes place in a free-market economy as new technologies replace old ones and new companies outcompete their more established rivals. This is often a very painful process on the microeconomic level, as people lose their jobs and investors lose their capital. Indeed, the phenomenon of creative destruction played no small part in the rise of the left in the late nineteenth century as means were sought to avoid the pain without losing the benefits of a technologically progressive economy.
But after numerous experiments with noncapitalist and mixed economies in the twentieth century, creative destruction has turned out to be indispensable at the macroeconomic level. First, because the government owns the means of production in a socialist economy, political considerations, not economic ones, have always dominated decision-making, and politicians will always try to preserve what is over fostering what might be. After all, what is votes; what might be does not.
Second, socialist economies have relied on monopolies to avoid “wasteful” competition and provide economies of scale. But all monopolies, whether owned by “the people” or by shareholders, tend to become fat, lazy, and uninnovative. Again, what is becomes heavily favored over what might be.
The inevitable result, from democratic, semicapitalist Britain in the years after World War II to the unspeakable tyrannies of Communist North Korea and Albania, has always been economic stagnation, lagging technology, and increasing relative poverty.
But even in the most capitalist countries, there have always been what economists call “natural monopolies.” These usually involve situations where such a heavy investment would be needed to provide competition that it would raise the costs above any possible savings. Electrical utilities are a typical example.
The long-distance market in North America was, only twenty years ago, the greatest natural monopoly on earth. Today, however, it is a ferociously competitive industry, as the endless stream of television commercials demonstrates. What happened? Most important, the development of microwave transmission technology—one of the myriad spinoffs from the invention of radar—made it possible for someone to compete with AT&T without duplicating Ma Bell’s vast landline infrastructure. This broke the natural monopoly. All that was needed thereafter was to break the regulatory one. That was not easy, for the Federal Communications Commission (FCC) was used to working closely with AT&T and had a natural tendency to favor it. Ironically, however, AT&T made, two decades apart, two trivial mistakes that each in no small way helped end the monopoly.
First, an elephant named AT&T tried to squash a mouse called Hush-A-Phone. It is characteristic, indeed instinctive, for a monopoly to protect its turf. Hush-A-Phone was so insignificant, however, that AT&T did not even notice its existence for nearly thirty years.
In 1921 a small company called Hush-A-Phone began to manufacture a device that could be fitted onto the mouthpiece of a phone. Because of its shape, it allowed the speaker to speak softly and be heard by the person at the other end, while people in the room could not listen in. It was a purely mechanical device and in no way affected the operation of the individual phone to which it was attached.
Then, in the late 1940s, an AT&T lawyer, taking a lunchtime stroll in lower Manhattan, noticed a Hush-A-Phone in a store window. He bought one and took it back to AT&T headquarters. The company moved immediately to have the Federal Communications Commission forbid the use of Hush-A-Phone on all AT&T equipment. Because in those days customers rented their phones from AT&T rather than owned them, that meant, for all practical purposes, every phone in the United States. AT&T argued before the FCC that Hush-A-Phone might interfere with its equipment and might even cause a catastrophic failure of the system.
The FCC, all too used to saying, “How high?” when AT&T said, “Jump,” ruled against Hush-A-Phone. Hush-A-Phone appealed to the courts. The U.S. Court of Appeals for the District of Columbia, unable to see how a bit of plastic screwed onto the end of a phone could have any effect whatever on AT&T’s continent-spanning network, ordered the FCC to reverse its decision.
The Hush-A-Phone case was important not in itself but in its use as precedent. From then on AT&T would have to prove, not merely declare ex cathedra , that an attachment to its system would harm the system. With the contemporaneous onset of the electronic revolution (helped mightily by the invention of the transistor by—you guessed it—AT&T) this began to occur more and more often, and AT&T’s monopoly began to fray at the edges. It was MCI, however, that unraveled it.
In 1959, faced with a rising tide of complaints against AT&T’s often high-handed ways, the FCC had allowed companies to establish their own microwave communications networks that bypassed AT&T, but only for internal use. This meant in effect that only very large companies with far-flung operations, such as Boeing, could afford them. MCI wanted to set up a microwave communications system between St. Louis and Chicago that would function as a common carrier. In other words, anyone could use it by paying a fee to MCI. AT&T, needless to say, was aghast at the prospect.
MCI had started as a store selling two-way radio service in Joliet, Illinois. Its owner, Jack Goeken, asked General Electric for the franchise in Springfield, Illinois, about 190 miles south of Joliet on the main route to St. Louis, and obtained it. Most of these radios were sold to truckers, but they had a range of only about fifteen miles. Worse, the dispatchers at each end of the St. Louis-Chicago corridor could not keep in touch with their truckers. Goeken figured if he could establish enough repeater stations along the route, he could sell a lot more radios. But to do this, he needed the approval of the FCC. So in 1963 he and four partners each put up six hundred dollars and, with this war chest, set off to get that approval. The FCC, of course, was not supposed to be in the business of protecting AT&T’s monopoly; its business was to see that the public interest was served. To prevent MCI from establishing a competitive system, therefore, AT&T had to show that MCI could not build its system at a cost that would allow it to charge competitive prices and that therefore the public would not be served by it and the license should be denied. Unfortunately for MCI, AT&T had virtually the only expertise in long-distance communications. The FCC had no choice but to rely on it when making decisions.
AT&T buttressed its argument that MCI couldn’t operate at competitive prices with facts and figures that no one could effectively rebut. Then Jack Goeken had a stroke of luck, and an AT&T employee made the other mistake. Goeken had heard at the FCC about a confidential report on microwave communications systems that AT&T had prepared for internal use only. He figured that his only hope of getting a copy was the direct approach, so he flew to New York, went to AT&T, and asked for a copy. When he landed in New York it was cold and snowing, and he had accidentally left his overcoat at the Hartford airport. Because he didn’t have a coat, the person he talked to at AT&T simply assumed that he must be an employee and told him the report was in the company library. He asked where—meaning “Where is the library?”—and she apparently thought he meant where in the library. She wrote out an official interoffice request form with the document name and number. Goeken realized what was happening, had enough sense to shut up, and found the library on his own. The report was his—and in it AT&T itself estimated far lower costs.
It would take six years for the FCC to grant MCI a license to operate, but when it did, the camel’s nose was under AT&T’s tent. A little more than a decade later the greatest monopoly in history was history.
For AT&T, the result has been an epic episode of creative destruction as it seeks to remake itself for a new competitive world. The process is by no means over. The results for the people at large, however, have been greatly improved service, swiftly falling rates, and a staggering rise in the use of long distance over the last two decades. In 1970 there were only 23 million long-distance calls. By 1980 the number had risen to 200 million, and in 1994, the last year for which statistics are available, the number was 3.713 billion. Moreover, the cost has dropped dramatically. In 1970 the average overseas call cost $10.76. In 1994 it was $2.18. Add in the effects of inflation, and the cost of an overseas call is only about 5 percent of what it was two decades ago.
Many years ago the science writer Arthur C. Clarke predicted that long distance would disappear by the early years of the new millennium and a phone call would be a phone call whether it went next door or around the world. He might very well be right, thanks to an ill-advised lawsuit and a lost overcoat.