Capitol Comment 248 – The Future Begins Now: Welcoming Regulators Into the Information Age

“Over the next five years, I believe the future of this medium will be determined more by policy choices than by technology choices.”

-America Online Chairman and CEO Steve Case, speaking on the future of the Internet at the National Press Club, October 26, 1998

Rent seeking is a term familiar to economists, but unknown to a vast majority of Americans. Simply defined, a rent seeker is a corporation or an individual who encourages government regulation of competitors to gain an advantage in the marketplace. Most Americans are familiar with the term in practice. Euphemisms such as level playing field are employed in its justification. The above quote from Steve Case is but one of hundreds of examples in which a corporate officer turns away from competition in favor of government regulation to guarantee or protect a share of the marketplace. Indeed, the history of corporate America is littered with examples of rent seeking.

Consumers intuitively understand the benefits of competition – lower prices and better products – but often fail to see behind the policies advanced by politicians and rent-seeking corporations that purport to encourage competition. The Justice Department’s current lawsuit against Microsoft is predicated on “enhancing competition” in the market for personal computer operating systems. In reality, it threatens to result in government regulation that will penalize the market’s leading competitor, Microsoft, and, by doing so, limit overall innovation and competition in the marketplace. It is no surprise that Microsoft’s biggest competitors – America Online, Netscape, and Sun Microsystems – and other firms who stand to gain market share if Microsoft is penalized, welcome government regulation of their marketplace. In this instance, they are rent seekers.

Nobel Prize winning economist Milton Friedman referred to this phenomenon as the “suicidal impulse of business.” Why? Government regulation employed to manage competition results in less overall competition in the marketplace. And, it follows, less opportunity for a challenger firm to unravel a leading corporation’s market dominance. Just as overall competition suffers, so do competitors because of fewer opportunities for success and consumers because of fewer innovations and higher prices.

The Department of Justice and some corporations claim strong similarities exist between the one-time monopolist AT&T and today’s Microsoft. Although each dominated large portions of the market in its day, there are fundamental differences between the two.

How do the market dominations of AT&T and Microsoft differ from each other? The chief difference between AT&T and Microsoft is the way in which they arrived at their respective positions. As a rent seeker, AT&T plied the halls of government buildings lobbying for a protected monopoly to become dominant. Microsoft relied on innovation and satisfied customers to earn its dominant position in a market previously dominated by the colossal IBM. In the first instance, AT&T became a monopoly by convincing politicians that it was best at meeting consumer demands. In the second instance, Microsoft rose to the top because it convinced consumers that it was the best at meeting their demands.

In 1915, Theodore Vail, then president of AT&T, convinced politicians that a government granted and protected monopoly could best provide telephone service to Americans. Having received a government-granted monopoly, AT&T ensured it would be the market leader of telephone service far into the future, but it also traded away the ability to capitalize on innovation. Rent seeking is a Faustian bargain. AT&T’s ability to bring new products to the market was strictly limited by the myopic vision of government regulators who, by constantly managing competition, stagnated innovation and provided consumers with fewer choices. The AT&T monopoly existed for 69 years until its court-ordered break up in 1984.

On the other hand, Microsoft’s market dominance, totally dependent on its ability to innovate and meet consumer demands, could be wiped out in a few years. In a market free from harmful government regulation, innovation is greater and consumer demands are met quicker. Moreover, no one firm’s dominance is ensured.

The case of Western Union demonstrates this point. Western Union controlled 80 percent of the traffic over the telegraph in 1880. Yet, by 1885 its market dominance had declined significantly. Why? Western Union President William Orton failed to see value in an 1876 invention – the telephone – and passed up an opportunity to buy the patent outright. In 1880 there were more than 100,000 handsets across America. By 1915, there were more than 11 million. Market forces, not government regulation, trimmed this corporate titan’s dominance.

Americans now recognize Western Union as a courier of yellow envelopes and a mover of money-grams, not as the communications giant it once was. Will Microsoft, with its 80 percent dominance in personal computer operating systems, fail to recognize the importance of a yet-to-come invention and follow Western Union? Right now, the freeware Linux and its supporters are challenging Microsoft’s dominance of the personal computer operating systems market – a challenge that came about without government intervention. In addition, Clayton Christensen, a Harvard University business professor who studies the rise and fall of great corporations, has postulated that “In the near future, ‘internet appliances’ may become disruptive technologies to suppliers of personal computer hardware and software.” In a market free from government regulation, it is impossible to predict what consumers and the marketplace have in store for Microsoft.