Monday, January 30, 2012

By Ryan Koven

With an election on the horizon and debate still raging over the defunct anti-piracy bills SOPA and PIPA, the symbiotic relationship between government and business is a hot issue. The discussion of internet piracy and enforcement of copyright law is a particularly prickly instance of this issue because it stems chiefly from the growth (and now near ubiquity) of a relatively young industry that enjoyed rapid growth in a somewhat relaxed regulatory regime. Though commentators try to frame the discussion of internet regulation as a struggle between free speech and the forces of censorship, the evolution of a new industry is a more relevant lens to analyze the issue. The early history of a related industry, telecommunications, offers some lessons, and possibly a preview of the direction of the debate.

The early 20th century witnessed rapid growth in the number of households with a telephone. The businesses that provided service to these new customers, called Local Exchange Carriers (LECs), also proliferated. Thousands of LECs managed hundreds of thousands of subscribers across the U.S. Competition for new subscribers became fierce, and prices for telephone service fell precipitously. In these heady early days in telephone history regulation of the market and oversight of the participating businesses did not exist, and new LECs emerged in every corner of the U.S. -- in both sizable metropolises and remote rural areas.

Telephone service evolved very differently in Europe, where the state took an active interest in regulating or owning the telephone companies from the moment Alexander Graham Bell phoned Mr. Watson in 1876. While an abundance of providers and plummeting prices fueled the penetration of the telephone into U.S. households, subscription rates in Europe lagged far behind the United States. In the 1930s the majority of U.S. households had a telephone, while most European countries reported that around 10% of households had a phone.

If the story ended here we might conclude that that the “free enterprise” model in the U.S. beat the state ownership model of Europe at managing the growth of a new industry and encouraging the adoption of new technology. But there are complications. Nothing obligated Local Exchange Carriers to connect with each other, and few of them could send calls through other LECs. Consequently, long distance service became difficult and expensive.  To make matters worse, the telecom behemoth AT&T made it a standard operating policy to not interconnect with independent LECs. Nicholas Economides, a professor of Economics at NYU’s Stern School of Business, summarizes the state of affairs at that time succinctly, noting that this lack of interconnection forced “many businesses to subscribe to two telephone companies with disconnected and incompatible networks, an independent to reach local customers (mainly households) and AT&T to reach suppliers.” This fact became a primary impetus to Federal regulation, and in 1934 the Telecommunications Act created the Federal Communications Commission in an attempt to regulate the industry.

The history of the telecom industry also suggests that an industry with little or no regulation is prone to monopolization.  AT&T emerged as an effective monopoly in the telecom sector, and enjoyed that status until another round of Federal regulation in the form of antitrust lawsuits brought by the Justice Department in the late 20th century. More recently, Jaron Lanier, a computer scientist, technology guru and writer, noted that the independent forums that exploded in the early days of the internet, and that he still uses to discuss, for instance, musical instruments, are threatened by “proprietary social networking.” In a recent New York Times op-ed he wrote that “like many other forms of contact, the musical conversations are moving into private sites, particularly Facebook. To continue to participate, I’d have to accept Facebook’s philosophy, under which it analyzes me, and is searching for new ways to charge third parties for the use of that analysis.” Lanier spoke of this reality as corrosive to the internet idealism central to the backlash against the internet piracy bills.

As industries evolve, new patterns of competition emerge. Economides, writing about deregulation in the telecom industry in the latter part of the 20th century, writes, “As a result of technological change, cost conditions shift considerably over time and can transform a market that requires regulation into one that does not.” The telecom industry in the United States in the early 20th century, if it ever was a market that didn’t require regulation, became transformed by new patterns of competition into an industry that required regulation. The “Web 2.0” industry is maturing, and the idealization of a wide open space with many independent, co-equal voices in competition may be changing. The history of the telephone suggests that such a free, relatively unregulated and unsupervised paradigm promotes competition and adoption in the early developmental stages of an industry, but that rapid growth will not be without pain, and will eventually be accompanied by supervision.