CHAPTER THIRTY-FOUR

The Lessons of the Bell Breakup

SUCH DISCUSSION OF THE BELL SYSTEM breakup as there has been, and there has been remarkably little, has centered mainly on the consequences for the shareholders and on share and bond prices. Yet few governmental actions since World War II will have such profound impact on American society, on American technology, and even on national security, as the antitrust suit against AT&T and the subsequent dissolution of the Bell System. Few so immediately affect every individual in the country. The antitrust suit and its sequel raise serious and disturbing questions about those twin pillars of the American political economy: regulation of business and antitrust.

Antitrust: The Cynics’ View

For antitrust cynics—and among economists they outnumber the “true believers” about ten to one—it is almost axiomatic that no major antitrust suit is ever brought until the alleged monopoly is already on the skids. For it is only then that competitors appear; their complaints that the monopoly is not collapsing fast enough push the antitrust machinery into action. And thus the antitrust suit, the cynics contend, achieves the very opposite of what the antitrust champions intend. By forcing the monopolist to stop defending yesterday, it restores his leadership position and gives him a near-monopoly on tomorrow.

This surely applies to America’s most celebrated antitrust suit, the one that resulted in the breakup of John D. Rockefeller’s Standard Oil Trust three-quarters of a century ago. The “monopoly” that Standard Oil had was on kerosene, which had been the petroleum product until Henry Ford’s Model T created a mass market for gasoline. In 1911, when Standard Oil was broken up, the gasoline market was still secondary but was growing fast, while kerosene was already in full decline and being replaced in all but rural areas by electric lights. And the gasoline market in the United States, and even more outside of it, was quickly taken over by aggressive newcomers such as Shell in England, Royal Dutch on the European continent, or Gulf and Texaco in the United States. Yet Rockefeller stubbornly clung to kerosene, on which indeed Standard Oil had a near-monopoly worldwide. It was only after antitrust had succeeded in breaking up the trust—in the process also dislodging the Rockefellers from active management—that the successor Standard Oil companies were free to concentrate on gasoline. Ten years later, they had 70 to 80 percent of the U.S. gasoline market and almost 50 percent of the gasoline market in the outside world.

Similarly, IBM would never have achieved worldwide leadership in the computer market had an antitrust suit not been brought against the company in the mid-1940s for monopolizing the punch card. But by 1947, punch cards were already becoming obsolete. IBM had actually done most of the work needed to give it leadership in the technology of tomorrow: the computer. But its stubborn defense of the punch card paralyzed it to the point that it actually stifled research on computers and on marketing them. The antitrust suit enabled the proponents of tomorrow in IBM management, especially the founder’s son, Thomas Watson, Jr., to shift the company’s efforts from defending the past to attaining leadership in the future.

The next antitrust suit against IBM, the one the government finally abandoned in 1982 as hopelessly confused, was also brought at the very moment when minicomputers and personal computers first arose to challenge IBM’s domination of the domestic market, and when the Japanese first became serious competitors in mainframe computers worldwide. The suit probably pushed IBM out of being content to be number one in mainframes and into frantic efforts to do something it had earlier spurned: enter the market for small and personal computers.

There is little doubt that the antitrust suit against AT&T (the Bell System), which ended in January 1983 with the split-up of the system, was similarly brought when the company’s monopoly had already been breached. It certainly forced the company to give up defending yesterday. What we do not know yet is whether it will, as the earlier suits did, enable AT&T to dominate the communications market of tomorrow: The challenge is clearly there.

A Phone in Every Room

Some thirty years ago, AT&T made the critical decision that would eventually lead to its being broken up. The company then ran its own Advanced Management School in Asbury Park, New Jersey, to which the “comers” in upper-middle management were sent for several weeks of intensive training, usually just before being promoted into their first senior management jobs. The assignment for one of these classes during the final week at Asbury Park was to think through objectives and strategy for the Bell System, now that it had achieved its original and long-term objective of providing universal access to telephone service for everyone in the United States. (As it happened, I was the guest lecturer at Asbury Park that week and in charge of the sessions.) The assignment was to work out one recommendation for Bell System top management. But the class could not agree and ended up—to everyone’s intense annoyance—with a majority and a minority report.

The majority recommended that Bell change its basic posture in the market. Whereas for more than sixty years the emphasis had been on providing everyone in the country with minimum service at lowest cost, the emphasis henceforth, the report proposed, should be on making people use their telephones as much as possible. This would mean pushing extensions in addition to the single telephone on the wall of the kitchen. It would mean selling more than one line to a customer (an extra phone for teenage children, for instance). It would also mean making the phone “interior decoration” rather than “utility” (Princess phones, for instance), or phones in colors other than black.

“All this is necessary,” the minority agreed,

Bell System’s top management took these recommendations very seriously and studied them carefully. In the end, it decided to adopt the majority report. It was, we know by hindsight, the wrong decision. But there probably was no choice. To go along with the minority would have meant forty-eight battles with forty-eight state public utility commissions. Moreover, thousands of Bell Telephone people throughout the country had been inculcated for years with the local-service creed and would have resisted any change. As it was, they strenuously resisted even the majority recommendation. “I have always been proud to provide public service and now they want me to be a huckster,” one Bell System friend said when he saw the first phones in “decorator” colors. Another friend, the chief engineer for one of the operating companies, had been complaining for years that his four teenaged children monopolized the phone in his home. But when he heard that his company was going to push separate “teenager lines,” he exclaimed, “This is immoral,” and immediately took early retirement.

There also did not seem to be any risk in at least postponing the shift in emphasis from local service to the fast-growing, nonlocal services. Bell, after all, was regulated. Thus it was considered in those days to be immune to antitrust and to be able to exclude all would-be competitors. It was an inevitable decision, but the wrong one.

The Shortsighted Hard Sell

The hard-sell campaign that the majority had recommended became a tremendous success. Within ten years it converted the home telephone from a utility into a convenience, if not into fashion and glamour. Few marketing campaigns in American history have been nearly so successful. Ironically, this great success in the end seriously damaged AT&T. It created a debilitating conflict between customer expectations and regulatory reality. AT&T’s marketing campaign made customers avid for novelty, for rapid change, for new features. But the regulatory realities—largely a reflection of AT&T’s earlier values—resisted novelty, rapid change, and new features. All forty-eight state regulatory commissions in the continental United States had long ago been taught by AT&T that their job was to ensure universal access to minimum telephone service at lowest cost. This meant, specifically, that AT&T was not permitted to write off equipment still in good physical condition, even though technically obsolescent, unfashionable, or “basic” rather than “sophisticated.” AT&T’s campaign created a market for rapid change in telephone equipment, whether receivers or switchboards. But AT&T kept hundreds of thousands—perhaps even millions—of obsolete models that were older but still perfectly serviceable and therefore could not be written off or junked. And so AT&T found itself caught between not satisfying the very demand it had worked hard to create and taking enormous losses on old equipment that might have endangered its financial integrity. Estimates of the writeoff run into the billions. AT&T, understandably trying to hedge, only created a market for potential competitors.

At the same time, the forecast of the minority report proved correct: Nonlocal service, long-distance telephoning, television transmission, and data transmission grew exponentially. In total numbers, calls within local areas still outnumber nonlocal calls. But both in demands on the system and in revenues, nonlocal services became, around 1970, the telephone system’s center of gravity and its dominant, if not its only, growth sector. By now, Americans spend two dollars on long-distance calls for every dollar they spend on local service. For the subsidized local subscriber, this was good news. But it also meant that nonlocal rates, and especially longdistance rates, became increasingly divorced from costs, all the more so as the rapid rise in the volume of nonlocal traffic brought about a drastic reduction in its costs. AT&T did the intelligent thing: It offered large discounts to volume users. But this only increased AT&T’s vulnerability, for it meant that anyone able to become a wholesaler—that is, anyone who could place enough individual long-distance calls to qualify for the wholesale discount—could underbid AT&T’s rates and still make a handsome profit.

Finally, telecommunications technology exploded—largely as a result of the scientific contributions of AT&T’s own Bell Labs. The transistor, switching theory, and information theory all came out of Bell Labs in the 1950s, and so did a good deal of computer logic and computer design. As a result of these breakthroughs, the telephone has virtually disappeared as unique technology. From AT&T’s vantage point, the computer—for instance, in an office switchboard or in a central station—is an adjunct to the telephone; from the vantage point of an IBM, the telephone is simply a computer terminal.

No monopoly in history has ever survived even one such change, let alone several. If competition is forbidden by law, it comes in through a black market, but it comes in. Sooner or later, and usually sooner, the law is then changed one way or another. This is exactly what happened to AT&T. “Extensions” into which phones can be plugged had been quite rare; AT&T’s big market push in the 1960s made them common-place. This then created the market for competitors who, at first semilegally, offered “decorator phones,” “fun phones,” and other, still officially forbidden, attachments. Then competition moved in on the office switchboard. AT&T had spent millions to develop electromechanical switchboards to take the place of the old, manually operated ones. But the competition offered computerized switchboards that leapfrogged over AT&T’s equipment. The technology to do so had come from AT&T. But because of its inability to write off, let alone to junk, old equipment that had become technically obsolete while remaining in perfect physical condition, AT&T had to stick with electromechanical, that is, outdated, instruments. Finally wholesalers came in—MCI, Sprint, and a host of others—who offered long-distance service to individual subscribers at 30 to 50 percent below AT&T’s rates. AT&T invoked its traditional right as a regulated monopoly to keep these competitors out. But the courts, reversing a century of decisions and long-settled legal doctrine, ruled in case after case that a regulated industry is not exempt from antitrust, and that AT&T could not discriminate against competitors, ban their equipment, or penalize competitors’ products in any way. In one important area, the impact on AT&T was immediate and substantial. In 1960, AT&T supplied almost all of the office switchboards used in America. Its share of the switchboard market by 1984 had fallen to less than one-third, with the bulk of new equipment being supplied by companies like ROLM that began as computer manufacturers.

The biggest loss has been in long distance. As late as 1981, AT&T’s Long Lines Department still handled 90 percent of all long-distance calls in the country. By the middle of 1984, its share had dropped to 60 percent. Above all, AT&T has lost the most profitable market segments: The larger users increasingly either build their own system to link their plants and offices throughout the nation or switch to telephone discounters such as MCI and Sprint.

From “Ma Bell” to “Monster Bell”

AT&T was thus increasingly forced on the defensive and increasingly trapped between the need to maintain high long-distance rates to subsidize local service and the need to cut long-distance rates to stanch the bleeding. Still, AT&T might have survived had it not been for inflation. The inflation of the 1970s eroded both the financial and the political base of the Bell System. And it undermined AT&T’s self-confidence.

Employees within AT&T’s own operations rarely know that their company has been one of the biggest nongovernmental financial institutions in the world. Not only has the company been the capital markets’ heaviest borrower year in and year out, for the telephone business is highly capital-intensive; AT&T has also been the country’s biggest lender. It has had to finance every single telephone subscriber for many years.

Traditionally, the subscriber did not buy the telephone connection to his home or his place of business, neither did he buy the equipment. The telephone company furnished both and was repaid out of operating revenues. And it took an average of five or six years until the subscriber’s payments fully reimbursed the telephone company for the installation investment. Originally this was necessary; very few people in the telephone’s early years would have been willing or able to pay the fairly large sums needed to buy the equipment. But in the years before World War I, Theodore Vail—AT&T’s president from 1905 until his death in 1920 and the architect of the Bell System—turned this necessity into virtue and profit. He realized that AT&T could borrow at far lower interest rates than an individual possibly could; historically, AT&T has paid between 3 and 4 percent for its money. AT&T could thus finance the customer at a very low rate—4.5 to 5.5 percent on historical average—and yet make a handsome profit. This not only gave AT&T tremendous financial strength and security; it also enabled the company to lower rates for local service even more. Thus everybody profited.

But this very best of all possible financial worlds came to a rude end when the inflation of the 1970s pushed the interest rates AT&T had to pay to 13, 14, and 15 percent. While the interest rate to AT&T changed, the rate to the telephone subscriber remained frozen. Financing the subscriber then became a dangerous drain. Market growth, that is, new subscribers applying for service, became a threat, which explains why the Bell Companies have been doing worst where population has been growing fastest (as in Southern California). Despite its automation, the telephone is still quite labor-intensive. And so, as inflation pushed up wages, AT&T and its operating companies were forced to ask for higher rates. But because financing of new subscribers—and additional installations for old subscribers as well—turned a riskless profit-making venture into a big financial loss, AT&T was forced to ask for even higher rate increases well beyond the rate of inflation.

In most parts of the country and for most services, the telephone, adjusted for inflation, still costs a good deal less than it did in 1950 or perhaps even in 1960. And American telephone service is still cheaper than telephone service anywhere else, with the possible exception of Canada. But for more than 60 years, the American public had known only declining telephone rates—and local subscriber rates had been declining both the fastest and the most consistently. Now, all of a sudden, telephone rates were going up, and local service rates were going up the fastest.

There surely has been far less “public uproar” over rising telephone rates than newspaper stories and television commentators have reported. For the most part, the public contented itself with writing a few letters to the editor. But the political impact was considerable. Governors, state legislators, and public utility commissioners realized that they could get headlines and gain popularity by publicly resisting requests for higher telephone rates and denouncing the “telephone monopoly.”

The psychological effect on the people at AT&T was devastating. Big companies—and big institutions generally, including universities, hospitals, and labor unions—tend to suffer from the dangerous delusion that the customer “loves” them. They are then shocked when they find out that a totally unsentimental and totally ungrateful customer only asks, “What will you do for me tomorrow?” But no institution in the United States—certainly no other business—has been so concerned with its standing in public opinion and so convinced of its being “loved” as the Bell Telephone System. This was by no means confined to top management. The lower ranks were even more deeply imbued with the Bell mystique.

And so the fairly mild protests against AT&T and its operating companies, protests which at General Motors would probably have been mistaken for expressions of endearment, came to the telephone employees as rejection by the beloved. A good many middle-management people I know in the Bell System feel as if their lives had been in vain. They had devoted their entire careers to serving the public, only to be attacked as greedy and reviled as profiteers. All along they had been confident of the public’s support, and now, when for the first time they needed the public in a time of financial erosion and increasing competition, the public was turning against them.

It was just then, when all the traditional foundations of the Bell System were tottering, that the Justice Department, on November 21, 1974, brought an antitrust suit asking for the breakup of the Bell Telephone System.

Breakup … Without a Fight

The AT&T suit has been documented more fully than any other antitrust suit in American history. Yet it is full of puzzles.

It is reasonably certain that the suit was brought only because of the political vacuum in the White House at the end of the Nixon presidency, which freed the antitrust lawyers in the Justice Department of political restraints. But why did the government pursue the suit? A presidential commission in the Carter administration condemned it as contrary to the national interest. Half a dozen members of the Ford, Carter, and Reagan cabinets recommended that it be dropped. And the Pentagon said publicly, on more than one occasion, that a standardized national telephone system under unified central management is absolutely essential for defense and must not be broken up. Yet neither Ford, nor Carter, nor Reagan did anything to stop the suit. Why?

The Justice Department, for its part, did little to push the suit. It waited six years, until January 1981, before bringing the suit to trial. And then it immediately adjourned the trial in the hope of a settlement offer from the company. The only rational explanation is that the higher-ups in the antitrust division were under pressure from their own “true believers” to bring the suit but expected to lose it.

AT&T’s behavior was equally puzzling. AT&T has worked harder on public relations than any other large corporation in America. Yet its efforts to mobilize public opinion through the close contacts it had built up over the years with newspapers, local politicians, and academics were pathetically inadequate. Bell System’s executives knew from the very beginning that much higher rates for those least able to afford them, the individual subscribers, would inevitably result from separating local from long-distance service, which was the antitrust division’s first and central demand. Indeed, anyone on the outside, even if only superficially acquainted with the economics of the telephone, knew this. Yet I know of no attempt to alert customers or even the various public utility commissions. Bell System management also knew—it was again obvious—that any change would mean both substantial layoffs and sharp wage reductions for Bell System workers. Like all protected industries, the Bell System was able to pass on wage increases to its customers and thus had been forced to keep both employment and wages artificially high. Yet apparently no attempt was made to enlist the 600,000 Bell workers or their union, the Communications Workers of America, on the company’s side in opposition to the antitrust suit. The union itself did not say one word about the suit that so clearly endangered it—perhaps even its very survival—even though opposition from the pro-union members of the Congress would almost certainly have put a fast stop to the suit. And Bell System management never, it seems, publicized the strong Pentagon protest. And yet, Bell System top management was emotionally committed to fighting the antitrust suit all the way without making any concessions and considered the suit to be both totally without merit and totally immoral. Indeed, judging from the plentiful published documents, top management in AT&T was preoccupied for several years with fighting the suit and had time for little else. Had Bell’s top management lost its nerve? Was it so overcome by its vicissitudes, and especially by its seeming rejection by the American public, as to have become virtually paralyzed?

All of a sudden, in the closing weeks of 1981, Bell capitulated. It voluntarily offered to divest itself of the operating companies and to restrict itself to long-distance and overseas operations, to the manufacture and sale of telephone equipment, and to telecommunications research. The decision came without any warning and as a surprise to everyone in the Bell System, where it was then generally believed that the suit would surely drag on until around 1990 and would finally be fought out in the Supreme Court. Instead, Bell accepted voluntarily most of what antitrust had asked for.

The only rational explanation for the sudden about-face of the Bell System top management is that it found itself forced to redefine its own role and function. Since Theodore Vail’s days in the early years of the century, AT&T has always seen itself as a “private company in the public service” rather than as a “private business.” It was in this tradition that Bell System top management felt itself duty-bound to fight the government antitrust suit as likely to damage the American economy, to penalize the poor, and to endanger America’s technological leadership (as we shall see, all perfectly legitimate concerns). But then, for six long years, no one in the public noticed their plight and came to their support—neither the media nor the administration nor the public utility commissions of the states, nor the labor union, nor even the Pentagon, which probably had more at stake in the antitrust suit than anybody else. And then, though one can only guess, the Bell System top-management people might have said to themselves, “If no one accepts us as defenders of the public interest, we have to do what the law tells us is our duty, that is, look after the interests of the company and its shareholders.”

And so, once they had capitulated, they acted with amazing speed. Two years later, on January 1, 1984, the Bell System breakup was complete. AT&T accepted competition in long-distance service and in providing instruments and equipment to the public. In return, AT&T was relieved of all responsibility for local service and with it of the responsibility to subsidize the local subscriber. This responsibility is now being shifted to seven independent large regional companies. Neither the operating companies nor AT&T has to finance the customer’s equipment any longer. They are now free to sell it. AT&T by 1987 will be free to set long-distance rates and thereby to fight back against competition that its former rate structure created and indeed subsidized. For the first time since the 1920s, when earlier antitrust fears made the Bell System sell its European manufacturing operations (after which it confined itself to North America, and since the 1950s to the continental United States), AT&T can compete worldwide. And it can engage in any business whatever, for instance, selling computers and office equipment.

But what specifically is the future for the operating companies and for AT&T? And what does the Bell breakup mean for the American telephone user and for American national security?

Regional Difficulties

Every one of the new regional companies into which the Bell System has been split has committed itself publicly to bold entrepreneurship and aggressive marketing, for instance, to leadership in cable television. But the future of the operating companies will depend on something far more mundane: on their ability to succeed in the traditional business of offering common-carrier service for a diversity of electronic messages going from one telephone instrument to another.

The former Bell System operating companies all face several highly turbulent years fighting for the rate increases they need to survive. Rates are already going up sharply and will continue to do so. Yet the antitrust suit promised, of course, that the consumer would greatly benefit from the breakup of the Bell monopoly. But in addition to losing the subsidy from long distance, the operating companies have to pay a good deal more for the money they need now that they are no longer sheltered monopolies. And they have to raise very large sums of money for equipment and facilities.

Second, they have to complete the shift they have only begun: from owning, leasing, and installing equipment to selling it. Within ten years, the operating companies will have to transfer to the customer the burden of paying for telephone instruments, and also for the connection from the nearest telephone line to the user’s building. They will not be able to finance equipment for the user, or be able to absorb the labor costs of installing and repairing equipment. Eventually this may lead to a new and profitable business—if and when interest rates come down. The Bell Companies may be able to start finance companies that will offer the consumer five- to eight-year installment finance on attractive terms. But this is well into the future. In the meantime, companies will have to persuade both the public and the public utility commissions of the forty-eight continental states (AT&T does not operate in Alaska and Hawaii) to allow them to withdraw from a service consumers and public utility commissions have been taking for granted for a century. We will thus inevitably see more attempts to guarantee low-cost telephone service for the poor, such as the recent California Universal Telephone Law. But this simply means that the subsidy to the local users that business—that is, high-volume long-distance users—formerly paid will now be provided by the taxpayer.

But perhaps even more difficult will be the labor problem. What the operating companies need is something like a one-quarter to one-third reduction in total employment and a one-quarter to one-third reduction in hourly labor rates and in the total labor cost burden. Historically, public utility commissions have automatically allowed the telephone company to pass along all employment costs and all wage increases. This is unlikely to continue, in part because rates have become highly politicized, in part however because unions—especially large, mass-production unions—have lost so much of their political power. Elected officials, such as public utility commissioners, are now clearly more afraid of taxpayers than they are of the union vote. And Bell workers, as employees of a protected industry, have achieved wage benefit levels higher than Bell’s competitors pay.

There are 600,000 members of the Communications Workers of America, and any reduction of staff and pay will hit hardest at installers and repairmen, the most highly paid but also the most completely unionized of all Bell workers. Yet they know that striking is not going to help them much; telephone service is so highly automated that most subscribers would not notice even a very long strike. Labor relations, in other words, are bound to be bitter on both sides, and turbulent.

Each of these tasks is difficult and represents a complete break with Bell System tradition. Each is going to cause raucous quarrels, bitterness, and bad publicity. But each will have to be tackled.

Learning to Compete

It is far more difficult to predict the future of AT&T, the former parent of the Bell System, now that it has been released from all parental responsibility—providing local service, installing and financing equipment—and from restrictions on the sale and pricing of its products, and the restriction to do business only within the continental United States. Or, rather, one has to predict “futures.” For AT&T is not one, but four major businesses, each quite different though interlocked with the others.

First there is nonlocal telephone service. For some additional time, AT&T may still labor under a fairly heavy competitive penalty. The competing long-distance services have lobbied, and with considerable success, to delay for a year or two AT&T’s proposal to levy “access charges” on local telephones, charges that would have curtailed the competitors’ rate advantage and have enabled AT&T to cut its own long-distance rates fast and sharply. But even after the penalty is finally removed (in 1987), AT&T will face an uphill struggle to get back the long-distance users it has lost, and especially the big ones among them. Whether it can ever regain its leadership is doubtful. A good many of the best long-distance customers, the very large ones such as the big multiplant companies or the very big banks, have been pushed by AT&T’s high long-distance rates into building their own private telephone systems. And so have several of the competing services. The biggest, MCI, is actually planning to build its own transatlantic circuits.

Even murkier is the future of AT&T’s second unit, the huge manufacturing subsidiary, Western Electric. In number of employees (150,000), Western Electric ranks tenth among American manufacturing companies; in sales ($12 billion) it ranks twenty-second. But in profitability it ranks well below 300, with a laughable return of 2.5 percent on sales and a return of 7 percent on assets—less than one-third of such comparable engineering companies as General Electric or IBM, and a good deal less than half of the minimum return an engineering company needs to defray its cost of capital. But, of course, Western Electric never had to compete, as the Bell System bought everything it turned out. It never was run for profit, but as a supplier to the operating companies. And it never had any credit losses, or inventories to write off, or marketing expenses.

Now, almost overnight, Western Electric will have to compete for every order it gets. Under the antitrust settlement, the operating companies have to consider every supplier rather than favor one of them—and the state public utility commissions will make very sure they do. All of the world’s traditional telephone equipment makers—Siemens from Germany; Ericsson from Sweden; the ITT companies from this country, Great Britain, Germany, France, and Belgium; NEC from Japan; and half a dozen others—are already in the American market hawking their wares to Ma Bell’s orphans. And the mightiest and the most aggressive new competitor, IBM, is moving full speed into the telephone business. It has bought ROLM, Western Electric’s most dangerous competitor in the switchboard field, and acquired a big stake in Intel, a leading manufacturer of the semiconductors that go into telephones and telephone switching gear.

On top of all this, Western Electric must break into a world market that it once dominated, but from which it retreated sixty years ago. It needs the volume. As long as Western Electric had to make everything the Bell Companies bought, and as long as the companies in turn had to buy everything Western Electric made, Western Electric had to produce an unknown but very large number of items that were neither the right products for its plants nor even remotely profitable. Obviously, it will not be able to sell these products from now on. And where, except in the export market, could it possibly get the volume to fill this capacity? The developing world is the market for truly advanced telecommunications equipment today, simply because developing countries (such as Singapore, Colombia, Kuwait) do not have large quantities of older equipment still functioning that would be too good to replace overnight. Thus, Western Electric has energetically moved out of the United States into a partnership with, for example, Olivetti, the large Italian office equipment and minicomputer maker. Yet the world market is already oversupplied with telephone manufacturers, and the big telephone orders—typically orders from national governments, of course—require the kind of financial encouragement that large exporters in Europe or Japan get from their governments as a matter of national policy, but that does not exist in the United States.

Western Electric has formidable assets in design, in engineering, in manufacturing—in everything, in fact, but marketing. It also has no choice but to try. But still there is no evidence that a frog can turn into a prince, and that is roughly what Western Electric is trying to do.

Does Bell Labs Have a Future?

The third of AT&T’s main units and the best known, Bell Telephone Laboratories, poses the most difficult decision. When the Bell System split itself up, top management announced that there would be no change whatever in the role and function of the system’s famed Bell Labs. But this, no matter how sincerely intended, is unlikely. Indeed, Bell Labs faces the most radical change in its history and its mission.

However, the antitrust settlement is only a minor factor in this, only the trigger. Bell Labs in its traditional form had actually become increasingly untenable for a long period of time, largely as a result of its own successes and contributions. Bell Laboratories’ discoveries and inventions have largely created modern “electronics"; they thereby eliminated the “telephone” as a distinct technology. To do what Bell Labs was founded to do in 1925 and did magnificently for 50 years—that is, to produce all the science and technology that a telephone needs—had become literally impossible. No one lab, no matter how good or how big, can possibly do this anymore. Everything in electronics, but also in solid-state or molecular physics, in metallurgy or in plastics, in crystallography or in computer sciences, and in a host of other disciplines, has a direct and immediate application to telephoning. And conversely, even the world’s biggest telephone system is not large enough as an outlet for the discoveries and inventions that come out of Bell Labs. Indeed, in a wide array of areas, from the transistor to fiber optics, and from switching theory to computer logic, the Bell System has been no more adequate as a conduit for Bell Labs’ scientific contributions than an eyedropper would be to channel a mountain freshet. The main users have been others—that is, nontelephone industries—with Bell Labs’ getting little out of its contributions other than an occasional footnote in a scientific paper.

The antitrust suit probably delayed by a decade the tackling of this problem. But now it must be faced. Under the new arrangement Bell Laboratories’ expenses can no longer be paid for by the operating companies. They can, of course, contract with Bell Labs for specific work if they so choose, but they no longer have an obligation to contribute. Considering the pressures on the operating companies to hold down costs, the forty-eight public utility commissions are certain to look with a very skeptical eye on any payment from the operating company in their state to Bell Labs. Bell Labs, in other words, suddenly may have only a fraction of its former economic base.

For several years it had been clear that Bell Labs could go in two directions. It could become a standard industrial lab of a big engineering company, comparable to the labs of GE, RCA, or du Pont. This does not necessarily condemn it to mediocrity; the GE lab can match Nobel Prize winners with any scientific institution in the world. But it is a very different role from that to which Bell Labs has been accustomed.

And then there would be a far bolder but also far riskier course: to convert Bell Labs into something totally new, a worldwide scientific laboratory in telecommunications and electronics, in business for itself, a lab that would aim at making a profit by taking research assignments from whoever is willing to pay for them, by developing its own patents and products to sell and to license, and so on. AT&T would still be the parent company of such a Bell Lab, but otherwise it would be just another client and would be dealt with at arm’s length. Nothing like this has ever been done. And no one knows whether it could succeed. But it clearly is the alternative to Bell Labs’ becoming another, though very good, industrial laboratory subordinated to a major manufacturing company.

The Bell System breakup, which deprived it of its financial base in the operating companies, surely tips the balance toward Bell Labs’ becoming Western Electric’s research and development department. It is hardly coincidence that one of the first organizational changes AT&T made after the breakup of the Bell System on January 1, 1984, was to put Bell Labs into the same organizational group as Western Electric and to subordinate it to the same management.

The Risk to Defense Communications

Almost no one, so far, has publicly even mentioned AT&T’s fourth major business: national defense communication. Yet it may be the most important, and the one most severely affected by the breakup of the Bell System.

Communications, everyone agrees, are the nerve system of modern defense. If communications do not function, defense collapses. Communications, everyone further agrees, are the one major area where the United States has so far enjoyed unquestionable superiority. Everyone also agrees that an enormous amount of work and effort will be needed simply to maintain our defense communications. For we now know that what we have is highly vulnerable to magnetic fields created by explosions in space. For “defense communications in the United States,” read AT&T. What gave the United States its superiority in defense communications were precisely the features of the Bell System that were abandoned in the antitrust settlement: complete integration of universal access, local service with universal long-distance service; complete compatibility throughout the system under unified central control; and, finally, integration of research on all levels, from pure science to product design and operational application. It was precisely because the antitrust suit challenged these features of the Bell System that the Pentagon strongly protested against it. But in the aftermath of Vietnam, nobody listened. What will happen now that the breakup of the Bell System is an accomplished fact? How much compatibility must there be in the nation’s telephone system; in telephone receivers, switchboards, and central stations; in long-distance circuits and long-distance service; in the ability to switch automatically from a damaged circuit to another route, so as to support mobilization, the organization of war production, and the transportation of defense material, let alone military command in time of war?

Under the antitrust settlement, defense communications are going to be fragmented. AT&T is bidding on the government’s long-distance business, but a lot of “discounters,” especially MCI, are also trying to get it. So is Bell Atlantic, the regional operating company serving Washington, D.C. There is going to be a host of suppliers offering different kinds of equipment to all government agencies, including the Defense Department. And AT&T is altogether forbidden to offer end-to-end services—that is, connections to local telephones—except for a few highly specialized installations at the Department of Defense and the Strategic Air Command.

But surely there is a point beyond which the fragmentation of our communication system endangers the nation. Pearl Harbor, we now know, happened in large part because a Navy telephone circuit was out of order at the critical time, while no interconnection existed to other undamaged circuits. Would we risk similar disaster if we have a number of competing long-distance systems rather than one integrated one, and if long-distance and local service are separated managerially, technically, and in their equipment?

We may thus soon be faced with the need to rethink the Bell antitrust decision as far as it affects national security. One possibility, and it is being seriously studied in the Pentagon, is for the military to build its own communications system. No one knows how much it would cost, but it would be extremely expensive; one guess is about $100 billion. It would also weaken the civilian telephone system by taking away from it its largest user and the one most willing to try out new technology and to pay for it.

But there emerged in April 1984 a totally different proposal: to repeal the antitrust settlement with respect to all governmental telecommunications and to turn all of them—local service, long distance, and equipment—back to AT&T. In fact, AT&T has already applied to the Federal Communications Commission for a waiver of the antitrust decree to allow it to submit such a bid to the government. I suspect that the Pentagon will strongly support AT&T; indeed, I suspect that the Pentagon has encouraged AT&T to make this bold move. Whether AT&T’s request will be granted is, of course, quite doubtful. There is no precedent in antitrust history for anything so bold and so radical.

AT&T’s request would go a long way toward nullifying the antitrust decree’s central feature: the absolute separation of long distance from local service. And it would do so with respect to the country’s largest single telephone user, the federal government, with a total telephone bill of nearly $2 billion. Above all, what AT&T is asking is for the government to admit, at least implicitly, that the breakup of the Bell System was a major and potentially disastrous mistake. Not only will all other providers of telephone service—former Bell operating companies, as well as all long-distance discounters and equipment manufacturers other than Western Electric—fight AT&T’s request, but within the government and in the Congress there will also be enormous opposition.

Still, it might be the only solution. And if AT&T’s request for a waiver is not granted, we shall sooner or later have to tackle the question of defense communications—and probably sooner. Some thoughtful people I know in the military, who are by no means alarmists, think the question might come up before the end of the next presidential term in 1988.

The Achievements—and Problems—of Regulated Monopolies

The AT&T suit was by far the biggest antitrust action ever taken, and not only because AT&T was the country’s biggest nongovernmental enterprise. It also had far more dramatic results than any previous antitrust suit ever aimed at or achieved. What, then, are its lessons for regulation and for antitrust—two pivotal American institutions—both, by the way, almost exact contemporaries of the Bell Telephone System?

The regulated monopoly was one of America’s most innovative and most successful contributions to the art of government. In one simple concept it solved what had seemed an insoluble dilemma: either to leave a “natural monopoly” to free enterprise and thereby give it a license to extort, or to nationalize it and thereby condemn it to almost certain bureaucratic arrogance, high costs, and inefficiency. Without exception, America’s regulated monopolies have given better service and have done better than nationalized counterparts in the rest of the developed world. The Bell Telephone System was, of course, the premier example, giving the country the world’s finest telephone service at rates up to 50 percent below those of any other industrialized country. American electric utility costs, too, are almost everywhere lower than those of electric utilities elsewhere with comparable energy sources (for example, coal, oil, or water power).

But even a regulated monopoly can become dysfunctional. As soon as there is any competition, as soon as there is an alternative way of producing the same consumer satisfaction or of filling the same consumer want, regulation becomes counter-productive. It no longer “regulates,” but it still forbids and stifles. It can no longer protect its industry and maintain its monopoly. But it can, and will, make it difficult for its industry to compete, to modernize itself, to meet the new threat. Yet there is no mechanism for abolishing outmoded regulation.

What then happens is messy, capricious, expensive, and bound to hurt a good many people, innocent bystanders included. The outcome is unpredictable and quite unlikely to be what is most rational and most in the national interest. In some cases we have left things to blind chance. One example is what is now happening in financial services. It bears not the slightest resemblance to what anyone would have foreseen or advocated when it first became apparent twenty years ago that our financial rules, demarcation lines, and regulations would rapidly become obsolete and meaningless. But with respect to the railroads, the outcome, equally left to chance, is quite different. What is now emerging, after thirty years of turmoil, and without the repeal of a single ordinance, rule, or regulation, is a system of five or so major national, if not transcontinental, railroads. That is almost exactly what a long-dead ICC commissioner, Joseph Eastman, proposed almost sixty years ago when it first became apparent that cars and trucks were nibbling away at the railroad’s monopoly on land transportation. Other industries, airlines and trucking, for instance, have been “deregulated” with the major result of forcing their workers’ wages down. And with respect to the telephone, we used an antitrust suit with results that no one can foresee as yet, but that almost certainly will not be what anyone—Bell System executive, antitrust lawyer, or disinterested outsider—would have foreseen, planned for, or aimed at.

Is there a better method? The answer is probably no. An old idea, a sunset law under which regulatory statutes expire every so often and have to be reenacted, say, every thirty years, is most unlikely to work. Every regulation creates its own constituencies. Regulation has to be undermined de facto; de jure it is likely to continue long after the reality of regulated monopoly has disappeared whether through the emergence of cars and trucks, through that of charter planes, through Citicorp’s becoming in effect a truly “national” bank, or through discounters’ offering long-distance telephone service at cut rates. Indeed, the one probable result of sunset laws is to tighten regulation just when economic and technological reality abolishes the natural monopoly. The only consolation may be that liquidating an obsolescent government monopoly is likely to be even messier, costlier, less predictable. (Witness the vicissitudes of the U.S. Post Office, beset on one side by electronic mail and on the other by private express services. Or examine the Japanese National Railroads, which are not allowed to do anything at all by their political and trade-union bosses, but which have already lost all their freight traffic and are now rapidly losing their passenger traffic as well, while unsubsidized private railroads paralleling the tracks of the national system run full trains to the same destinations, charge half the fare the national system charges, and make money into the bargain!)

Antitrust Moralism

Antitrust, too, was an American contribution to the art of government, but a far more debatable one. It may come as a surprise to laymen to learn that most American economists have never had much to say for the antitrust laws. They consider such laws morality rather than economics. One reason is that economists, by and large, are not terribly frightened by nongovernmental, that is, business, monopolies. Ever since a German economist, Robert Liefmann, published his comprehensive study of business monopolies ( Die Kartelle) in 1905, economists have known that business (that is, nongovernmental) monopolies are short-lived. All they do, as a rule, is provide an umbrella of high prices under which competitors then grow fast and risklessly. Thus, Rockefeller’s Standard Oil Trust held an umbrella of high prices over the newcomers—Texaco, Gulf, Shell—eighty years ago. And the Bell System held an umbrella of high long-distance rates over such discounters as MCI and Sprint. The only exceptions are what Joseph Schumpeter (1883–1950) called intelligent monopolies, that is, monopolies that maintain their leadership position by cutting their own prices before competition does, and faster than competition can do it, and that themselves make their products obsolete before the competition does. Schumpeter’s example was the Bell Telephone System—and that was, of course, the foundation for Bell’s strength until it ran into the inflation of the late 1960s and 1970s. Another example would be IBM today. Intelligent monopolies may indeed last a long time, but of course the intelligent monopoly uses its economic power to benefit the consumer rather than to extort from him.

There is an even more important reason, however, for the jaundiced view most American economists take of antitrust: They see no results. Or rather they see only wrong results which are almost the opposite of what antitrust promises. In terms of concentration of economic power, the American economy, despite antitrust, differs very little—and certainly not in statistically significant magnitudes—from any other economy in a similar stage of development, even though most of these others have had no antitrust laws and have certainly not enforced those they have had. Indeed, it is pretty obvious that concentration is determined by technology and market forces rather than by law and is pretty much the same in the same industries across all boundaries. But as a result of antitrust, economic concentration and combination in this country have taken peculiar forms, and not necessarily the most benign ones. Antitrust has enormously encouraged mergers. For under the antitrust laws, units within the same legal entity are considered one business and are basically exempt from antitrust with respect to their dealing with one another. In other countries, however, there is the group rather than the merger. In the group, the individual units maintain their independence and identity though tied to each other through stock holdings (usually minority holdings, by the way). Antitrust would, however, consider the group, composed as it is of independent legal entities, a clear violation; as a result, antitrust has greatly favored the disappearance of autonomous, self-governing, and smaller enterprises in favor of the behemoth. And then because antitrust frowns on concentrations of economic power in the same markets, it has virtually forced American companies to grow by forming “conglomerates” without organic or business unity (for example, ITT’s telephone equipment businesses’ adding to themselves a bakery and an insurance company). Few economists would consider the merger preferable to the group, or the conglomerate preferable to either.

This will not, of course, impress antitrusters in the least. That economic concentration in this country, despite its antitrust laws, is no lower than among the heathen proves only two things: the antitrust laws have to be enforced much more strictly, and the evil is even more powerful, more wicked, and more devious than anyone could imagine. To economists, laws like antitrust are hygiene. To the true antitrust believer, they are morality. And morality, at least in the United States, always has a great deal more appeal than something so pedestrian as hygiene. Most American economists would agree that even repealing the antitrust laws in their entirety, let alone their monopoly provisions, would not cause great harm to the American economy. The offenses that need to be forbidden—price fixing, discriminatory pricing, discriminatory rebates—are adequately covered by common law, after all, and are adequately dealt with in countries that are totally innocent of antitrust legislation. Still, antitrust is sacred. A proposal to repeal the bans on “concentration” and “monopoly” would have about as much chance of success as a proposal to close all law schools for the next thirty years.

The Social Costs of Antitrust

But still, the AT&T suit has shown that some reforms should at least be seriously considered. The first one might be to introduce into antitrust the overwhelming consensus among American economists about what is “analysis” and what is “policy.” “All economists,” an oft-quoted saying goes, “agree that the only purpose of economic activity and its touchstone is the consumer. Anyone who believes that the purpose is anything else (employment, for example) is not an economist.” Not quite true, but it will do.

For the great majority of American economists, and of economists anywhere, this however applies only to economic analysis and not to economic policy. But for a tiny minority—George Stigler in Chicago and his disciples—it applies to both. To some considerable extent their influence has been wholesome. Stigler’s insistence that in economic analysis nothing else be considered but strictly economic factors is a badly needed antidote to the sloppiness that prevails in arguments about economic policy. It is indeed highly desirable, as Stigler has demanded for years, that policymakers start out with the knowledge of the purely economic facts so that they face up to the costs of any deviation therefrom in the policy they then choose.

But his disciples go much further. They demand that no deviation from the pure economic analysis be followed in deciding on economic policy. And Stigler’s disciples control antitrust. To consider anything else—impact on foreign policy or on defense, social consequences, anything—is impure if not prostitution. For the antitrust economist, the benefit to an abstract consumer is the only consideration. The Chicago economists, for instance, refused to accept as relevant the argument that a Bell System breakup would inevitably mean higher rates for the poor and lower rates for business; the only thing they allowed was the total impact on all consumers, that is, the total national telephone bill. For, as the group argues, any concession, any deviation is the first step down the slippery slope. It is “playing politics with the law.” To the great majority of American economists, this is virtue carried to the point of madness.

For antitrust is politics. The Reagan administration declared in the winter of 1984, in connection with an antitrust ban on a proposed merger between two very large steel companies, that “it does not allow politics to enter antitrust; it is entirely a matter of the law.” This is sanctimonious twaddle, and disingenuous to boot. A major antitrust suit is, of necessity, a highly political matter—and the way it is settled even more so. The suit against AT&T, for instance, would hardly have been brought had inflation not eroded the company’s support to the point that it became politically vulnerable. And the whole point of the steel-merger decision was political: whether it is politically preferable to allow major steel companies to merge rather than to impose import restrictions on steel from Europe and thereby to risk a trade war with the Common Market. And, indeed, no sooner had the White House officially declared that it had nothing to do with the steel-merger case than antitrust reversed itself and allowed the merger. It is also simply not true, as the antitrust economists maintain, that there exists no reasonably rigorous and objective theory to consider extra-economic factors in an economic-policy decision. That theory has been in existence for fifty years now, in the welfare economics of Arthur Cecil Pigou. What welfare economics does is determine, with considerable precision, the economic costs of trade-offs from the purely economic, purely consumer-focused result of economic analysis. How much would it mean in additional costs if, for example, long-distance rates were maintained at a higher than strictly economic level to provide subsidies for minimum local service? How much would it cost in economic terms to make this or that social or political concession? What, in other words, are the economic costs of a given policy? Policy, by definition, can never be just one thing—that is, social or economic or military—it always has many dimensions. Who loses, who benefits, and by how much?

But the antitrust economists are quite right: The answers to these questions are not really to be found in the law any more than are the settlement terms for an antitrust decree. What is therefore needed (and, by the way, most judges would agree) is to divorce analysis from policy in major antitrust suits as we routinely do in so many other areas. Legal and economic analysis should govern until a company or an industry is found in violation. But then a panel of high-level experts—maybe one nominated by the prosecution, one nominated by the defense, one a public member (or a panel appointed by the Council of Economic Advisors)—would work on the trade-offs, the welfare economics. The panel should probably be limited in its considerations to a fairly small number of issues: major social impacts; major economic impacts such as those on productivity, capital formation, and employment; the impact on America’s competitive position in the world economy and on America’s technological leadership; the impact on national security. In the AT&T case, such a panel would surely have recommended continuing financial support of the Bell Labs by the operating companies. And it might also have forced us to face the problem of defense communications. The panel should advise rather than arbitrate, the judge making the final decision. But the judge needs advice; nothing in a judge’s background or career qualifies him in these matters. They are also matters that can only be mismanaged if handled in adversary proceedings.

Of course any such reform, or anything even remotely like it, is in the future. But it may not be a very distant future. If the Bell breakup works out and if ten years hence the United States still has telecommunications leadership, well and good. But if, as is quite likely, the ten years after the antitrust liquidation of AT&T’s “natural monopoly” bring more gadgets but otherwise only increased costs, damaged technological leadership, and compromised national security, we may then be ready to reconsider.

(1984)