All Commentary
Sunday, December 1, 1996

Free-Market Economics in a Phone Booth

The Benefits of New Competition to Telephone Users Are Dramatic

Dr. Shannon is professor of economics at Clemson University, Clemson, South Carolina.

In The Wealth of Nations, published 220 years ago, Adam Smith argued that the interests of consumers would be better served by an open system of free markets than by the regulated regime of mercantilism that prevailed. Competition, Smith maintained, was more efficient than monopoly. Could anyone oppose Smith’s policy prescription?

We have before us now a simple, straightforward example of Smith’s point, which also shows why some people oppose his principles. An article in the Washington Post National Weekly Edition dealing with the breaking up of AT&T, the giant telephone company that was once a monopoly protected by the federal government, includes some statistics obtained from the Federal Communications Commission, AT&T, and the U.S. Labor Department that are marvelously pertinent to Smith’s thesis.

In the early 1980s, in part as a result of rapid technological improvements (such as fiber optics), not only was AT&T forced by judicial decree to break up into several regional components (the so-called Baby Bells), but also other firms were allowed to compete with AT&T for long-distance telephone service. As everyone who has seen the ensuing barrage of TV commercials surely knows, new firms did enter the market—with a vengeance. What has been the result of replacing monopoly with competition in long-distance telephone service?

First, the average cost of long-distance service has dropped dramatically, from about 50 cents per interstate minute in 1982 to less than 20 cents in 1994, a decline of more than 60 percent. Second, interstate consumer telephone use has almost tripled since 1982. (In the jargon of economists, it could be said that consumers’ demand for long-distance telephone service was elastic, causing the total amount of money spent on such service to go up when the price fell.)

Of course, AT&T has not been the sole recipient of all this new demand for phone service, and as a result has been engaging in drastic downsizing and reorganization. So a third result is that many of its employees have lost their jobs. Indeed, this impact was the focus of the Post’s article, “Ma Bell’s Changing Tone.” The subtitle told the whole story: In a reordered corporate world, it’s employees who pay the toll. The article gave a detailed account of how AT&T had changed from a company that provided a virtual assurance of lifetime jobs when it was a protected monopoly to a firm in which a worker’s future is far more precarious.

As the Post article notes, because customers no longer felt loyal to AT&T (nor did investors, who were unhappy with its profit performance), why should AT&T be loyal to its employees? Since the company was broken up, employment has dropped by about 60 percent, from nearly one million employees in the early 1980s to about 400,000 today.

But to focus on this fact is to miss the doughnut for the hole. The Post data also reveal a fourth effect of this movement to freer markets: employment in the communications industry as a whole has remained high; it peaked at about 1.6 million in the early 1980s and is around 1.5 million today. So breaking up AT&T did not destroy jobs—it relocated them.

The hardships imposed on employees who must suddenly seek new work should not be overlooked. The costs of retraining and relocation can be significant, and crippling. Political power is often used to alleviate such woes; after all, that is the argument behind unemployment compensation.

But surely it is equally important to note that, when competition replaces monopoly, the costs imposed on the few are vastly offset by the benefits that accrue to the many.

A very similar story has been told by the economist Russell D. Roberts in his splendid little book The Choice: A Fable of Free Trade and Protectionism. Roberts explains that opening up to free trade may destroy some domestic jobs in the present, but it will create vast new opportunities for our children in the future.

Of course, the world-wide movements toward privatization, given initial impetus when Margaret Thatcher was Prime Minister of the United Kingdom, and perestroika, the decentralization of economic activity proposed (but not actually pursued) by the Soviet leader Mikhail Gorbachev, are both ongoing efforts toward creating more competitive economies. Communism and socialism differ from mercantilism in that communist governments directly own industries, while mercantilist governments simply regulate them. But the practical economic effects are largely the same; stagnation and low incomes are the prices people pay for such extensive intervention in economic activity.

Our federal government no longer protects AT&T’s long-distance monopoly. The benefits of the new competition to telephone users are dramatic—and should be clear to all who care to look.

Yet much resistance to free enterprise remains, both in the United States and abroad. Those of us who live and work in this country today have benefited enormously from the free markets of the past; our standard of living is substantially higher because our ancestors paid the price, accepting less job security in exchange for the expectation of a rising standard of living. Don’t we owe it to future generations to carry on this tradition?

  • Dr. Shannon was professor of economics at Clemson University, Clemson, South Carolina.