Those Who Don't Learn from Telecom History Are Doomed to Repeat It

A few days ago, FCC Chairman Ajit Pai announced his plan to hold a final vote next month to roll back the "Net Neutrality" regulations imposed in 2015 under the previous administration. This has led to a lot of hysterical overreaction, such as headlines proclaiming that the "FCC Is Revving Up to Destroy the Internet as We Know It." This obviously counts on ignorance of history. The Internet started in 1969 (depending on how you count), and people have been using the World Wide Web for 22 years. So I don't think reversing a regulation from two years ago is going to destroy it.

But there's a deeper ignorance of history involved, one that I discussed with technology entrepreneur Bill Frezza back in May: the history of the AT&T monopoly, how it suppressed innovation, and how this parallels some of the provisions of "Net Neutrality." This interview got lost in some of the upheaval connected with the late, lamented RealClearFuture. You can listen to it now, and below is a transcript.

Rob Tracinski: I'm here at FEECon in Atlanta, the conference of the Foundation for Economic Education, and I'm talking to Bill Frezza, who is a technology entrepreneur, and I first met Bill because he was involved with the Competitive Enterprise Institute as an advocate for free markets.

The reason I want to talk to you today, Bill, is you gave a great presentation earlier today--I'm sorry, yesterday--gave a great presentation on the history of AT&T and the telephone monopoly and how that connects to the birth of the Internet. And it's--you know, I'm just old enough to remember some of that history and to remember when Ma Bell controlled everything, but there was a lot of interesting new details that I wasn't familiar with that are surprisingly relevant to today and to some of the discussion over the Internet and Net Neutrality.

So I want to start having you kind of tell a little bit of--well, you were present at the creation in some ways.

Bill Frezza: Well, you know I lived through much of the telecom industry that we enjoyed. And what I find most surprising about particularly Millennials, the young generation, is this memory hole that all this history's gone down. They were born in the digital age. They don't know what came before it. And if they want to help influence policy in the future they have to understand what happened in the past.

RWT: During your presentation, you were mentioning how the old telephones used to have that ring and somebody said, "Oh, like on the iPhone." And all of us over 35 in the audience were smacking our heads.

Frezza: Yeah, the old mechanical bell. And so I've been basically telling this story on college campuses for the last couple or three years trying to get people to understand that the roots of the Internet go back to 1913. And I usually start my talk with two questions, and I always know the answers to these questions, and it surprises me every time that it comes back the same. I introduce myself and I ask the college kids, raise your hand if you own a phone. And of course they look at me like I have two heads. You know, how could you be a human who doesn't have a phone? And then I go to the next question, I say, how many of you know that when I was a kid in America, it was illegal to own your own telephone? And they're perplexed. They've never heard such an absurd idea in their lives. What do you mean it's illegal to own your own telephone?

It was illegal to own your own telephone. You had to rent it from the Bell monopoly. On the back of every telephone there was a little metal tag, and it said, property of Western Electric. Western Electric was the only manufacturer who was legally allowed to manufacture phones in United States, and the only place you can get it is from the Bell System. And this had a lot of consequences that they know nothing about. They're shocked.

So I take them back in time, and I give them a little history of the telecom industry. Starting in 1980, excuse me, starting in 1876 when Alexander Graham Bell developed the telephone on top of the telegraph industry, there was a dynamic period of innovation and competition really unequaled in many other industries. There were dozens and dozens of phone companies competing to wire up the cities. If you Google up old photographs of telephone poles in the cities--

RWT: You see, like, spaghetti going across the streets, right.

Frezza: Spaghetti! And people put up with the eyesore because, what a wonderful innovation this telephone was, and so, you know, may a thousand flowers bloom, and all these companies were going at it. And innovation was at a frenetic pace. Garage shop inventors were coming up with new switches.

RWT: There's a great story, I don't know if we can get into it, but a great story of the guy who invented--the undertaker who developed the electronic switch.

Frezza: Not electronic, electro-mechanical switch. So it turns out this undertaker in a small town--his rival's wife was a telephone switchboard operator. And all the calls "to the undertaker" were going off to his rival, and in a fit of pique he went into his shop, and he developed the Strowger switch, the very first electro-mechanical switch.

RWT: That is the glory of capitalism right there in one story.

Frezza: And it went away! And why did it go away in 1913? Well, it turns out one company got an edge on the other competitors. It was American Telephone and Telegraph, and their key was they began running wires between cities and offering long distance service, and they were very, very clever in how they ran their business model. They would come to a city they hadn't connected before. There'd be four or five competing telephone companies, and they'd bring them in, and they'd say, you know, we're going to connect one of you. Not the other three or four.

RWT: And you had better be the one.

Frezza: And we're going to make you an offer you can't refuse. We're going to buy you. And they used that as the foundation of a rollup strategy, which was absolutely brilliant, but it earned the wrath of the antitrust regulators. Remember, this was the era of the trustbusters and Teddy Roosevelt and all the rest of that.

RWT: So the head guy at AT&T comes and makes an offer they can't refuse to the federal government.

Frezza: The greatest crony capitalist in American history, probably the greatest crony capitalist the world has ever known--but I don't know enough international history to be sure of that. And what made him great....

RWT: What was the guy's name?

Frezza: His name was Theodore Vail. He was the president of AT&T. He was not an inventor, he did not found the company, he was just a very, very clever businessman who understood politics, and he made a deal. And he said to the American people, through an antitrust settlement, I'm going to wire up the whole country. I promise to develop universal service. People will be equal before the telephone.

RWT: So even the guy way out there on the farm in Idaho, he's going to get it.

Frezza: What a wonderful promise. Not only will the guy way out there on a farm in Idaho get a phone, he's going to pay the same prices as a city slicker, even though the city slicker lives in a 100-unit apartment building across the street from the central office, because I'm going to cross-subsidize this whole thing. I'm going to build out the country, and I'm going to let you, Mr. Government, set my rates. He invented, basically, the public utility model of regulation, which was then copied by the electrical industry and the water industry. Whereas a public utility commission would be empowered using our statewide basis--he would open up the books. This was quite a promise. I'm going to show you my books. I'm going to come before you and make what's called a rate case, which was still in place all the way through the early 80s. I'm going to tell you what my invested capital was, and all I want is a fair rate of return: 12 percent. Right?

RWT: Yeah, very fair!

Frezza: And what you have to do for me is put all my competitors out of business by law. In something called the Kingsbury Commitment, that was that promise, they made that rule in 1913 and for 70 years, except for a few rural areas where there are some exceptions, they were the only legal telephone company in America.

And what made this crony capitalist so dangerous is that he kept his promise. He actually delivered. He wired up the whole country--took a while. You know, back then things took a little longer. He was very able to attract capital because who doesn't want a 12 percent rate of return--riskless rate of return. It became a widows-and-orphans stock. The unions loved it. No competition, they build it all into the rate case. Everybody was happy. And what happened was he wired up the country, and that was what Bastiat calls "that which is seen." Everybody got to see and be proud--when I joined Bell Labs in 1978, it was my first job out of MIT--everybody was really proud of the American telephone system. We were the model for the world. That public utility model was copied in many other countries. Often the post office was the one around the phone company. And they did a pretty good job of plowing their profits back into expansion. They built this Bell Labs, which was supposedly the gem of the research, industrial research laboratories, that invented a lot of interesting things. They reduced their costs. But what's interesting is, they never reduced their prices.

So the unseen of this great monopoly was that consumer-side evolution pretty much stopped for 70 years. And a perfect example of this--and I shocked the kids when I asked them this--my dad grew up in a tenement in upper Manhattan, on the Upper East Side, and they had a phone. They shared it with their neighbor. That telephone from the 1920s, you could have picked up and plugged into the phone network in the 1970s-1980s when I joined Bell Labs, and it would have worked fine. And I asked the kids how many of you think your phone, the phone you carry your pocket, is going to work 50 years from now? And they look at me. How many of you want that phone to work 50 years from now?

RWT: It's just inconceivable.

Frezza: Inconceivable that you would want such a thing, that stagnation would be desirable. You know, in 70 years, I like to say, AT&T developed seven apps in 70 years. Seven apps in 70 years, right? So otherwise the phone was the same. Yes, they developed direct distance dialing. You didn't have to go through a switchboard operator to get long-distance.

RWT: They developed the touch-tone phones. I remember when that was a big deal, the touch-tone, you didn't have to do the dial which would go click-click-click-click...

Frezza: They had directory assistance, because if you didn't have a phone book for the whole country, you had to call to get the number. And then very much toward the end, when the number five ESS came out, they introduced custom calling features, so call waiting, call forwarding, and centralized voicemail. Very much toward the end, but consumers put up with no progress for 70 years in return for equality. This was the key to the promise.

RWT: What I find interesting is the way that universality and equality had a role in preventing that innovation from happening, because if you wanted to introduce something new, you had to do it for everybody, equally.

Frezza: Anything introduced to the market had to be equally available, and so that precluded offering things to certain customers that might have been advantaged. And before I leave the price issue, this is another way I shock the college kids--I tell them that when I was in college, I was a freshman in college, I would call mom once a week. You have to pick your hours, right? Because remember there used to be different rates at different hours, And a three-minute phone call home to mom cost exactly the same as two pitchers of beer and three bags of beer nuts. A pitcher of Bud was a buck and a quarter my freshmen year.

RWT: I'm guessing you didn't call mom that often.

Frezza: There you go. So, "hello," "hello," and you'd hang up because this was long distance, I gotta hang my phone up, right? That's the world we lived in.

Technology everywhere else makes things better, faster, and cheaper relentlessly. Only in these over-regulated industries does the opposite happen. And when I was at Bell Labs, for example, and they were talking about the future--because we knew data was coming, right? I was working on something called videotex, which was sort of an early failed version of the Internet--electronic newspapers and electronic shopping and all very centralized and centrally planned with big corporate partners. There was a paper that was published in the Bell System technical journal that proved you can never put more than 9600 bits per second down a phone line--which we now know to be ridiculous.

RWT: I remember when we actually did send 9600 bits per second on a phone line with a dial-up modem.

Frezza: This was looking at more advanced technologies, but they were looking at the physical limitations of the copper wires. And in fact, if it has to be available on every pair of copper wires, including the five-mile loop with the load coils going out to the farmer--well you can't push more than 9600 baud through.

RWT: Yeah, it is precisely because in order to upgrade it or improve it you had to do it for the entire country, and you couldn't charge anybody any more.

Frezza: It was the National Health Service of Great Britain, in the telephone industry.

RWT: And what strikes me is, it's so much the part of Silicon Valley--part of the core business model of Silicon Valley is the idea of the early adopter, the guy who wants to be on the bleeding edge and is willing to pay a lot of money for something doesn't necessarily work all that well yet. Tesla would not exist without those people.

Frezza: The guinea pigs, right. In every field--wouldn't it be wonderful if rich billionaires with cancer became our guinea pigs and got to try these new drugs first?

That was not allowed, up until 1982. So what happened is at the very end of the Bell System's run they were getting itchy, they were once again under assault by the Justice Department in an antitrust investigation, and the powers that be at AT&T really wanted to go into the computer business. One of the rules of this consent decree, the Kingsbury Commitment, was they couldn't go into new businesses because now you'd have a monster. If you had this 12 percent rate of return guaranteed company that started, you know, going into the car business, you'd have a problem. Well, they were building computers. They were inside their switches. They invented Unix. Why can't we be in this business? So they cut a deal. In 1982, the Bell system was broken up, and the subsequent 20 years was the most exciting, innovative, competitive time ever. And I had the good fortune to be a young engineer at the time.

RWT: And the AT&T computer didn't--I actually remember seeing AT&T PCs running Unix for a very brief period of time.

Frezza: And this vaunted Bell Labs disappeared under the waves. It ended up being part of Lucent, which got bought by Alcatel.

RWT: But all the people who were at Bell Labs, such as yourself...

Frezza: The talented people left. They actually paid the most talented people to leave, and the hangers-on went down with the ship. But there was a diaspora. One of the consequences of this universal service model is, if you wanted to be a telecom engineer the only legal place to work was in the Bell System at Bell Labs. You hogged all the talent. As soon as our talent was released, and as soon as two guys in their garage in Silicon Valley could start building products, everything changed in the industry. The entire digital revolution happened, and luckily Bell System's master plan for data, which was called X25, was never executed. Instead, this little petri dish of an experiment called Arpanet became the seed for the Internet. And that's a whole other story.

RWT: And I don't want to go into that now, but you go into how it was a totally noncommercial thing. Tiny, not scaled up. It actually was against the rules of the Internet to buy and sell anything. I'd forgotten about that. I used, I was on e-mail in 1987 because it was at the university, and I forgot that you couldn't--you know, you had to have a university affiliation, get a university account. And it's just something that never struck me until you just said that right now, that there was never any buying or selling on this early version of the Internet.

Frezza: If you want to put the lie to the story that--not just the story that Al Gore invented the Internet, but the story that this was central planning and a master plan by the government, you have to remember the fact that the acceptable use policy that was controlling the early versions of the Internet, which were mostly university-connected systems, outlawed all commercial traffic. You couldn't buy and sell, you couldn't advertise, these were evil things. And it took a fight. I was there on the frontlines in Washington, actually fighting Ralph Nader and his minions who believed that the Internet should be like a public utility, like the library of Congress, and it should never be besmirched by anything as horrible as profits.

RWT: And of course once it became commercial that's what built everything.

Frezza: That's what sucked in the capital. And people say, well, the Internet's backbone was built by the government. Not entirely true. First of all, the Internet doesn't really have a backbone. It's a giant mesh. It's a self-organizing network of networks.

RWT: It's this vast infrastructure required to sustain it, and that wasn't built by government.

Frezza: No, no, and in fact, to give the government credit--and this is going to be a backhanded compliment--what they paid for was the development of the initial protocols. A bunch of scientists wanted to connect to computers. They came up with something called TCP/IP, which is with us today. If you were really planning on building a commercial network, you would never design it around TCP/IP. It is so full of flaws and holes and missing features, all of which had to be grafted onto it later at great pain and difficulty. And most of the sources of our misery, the spam, the phishing, the lack of authentication, the inability to prioritize traffic--all that came because they didn't plan any of this stuff, it all grew organically. And it was that commercial, for-profit money. It was the Sprints and the MCIs that ran out there to put the infrastructure, particularly when the fiber optics really became of age, that created the Internet that we knew. <p And it's a tragedy to see people using the same arguments that were used back in 1913 to try to re-regulate the Internet.

RWT: And that's what I wanted to get to which is that--the relevance to today is, the universality and equality were the things that killed innovation.

Frezza: The enforced equality.

RWT: Exactly, the requirement of this artificial equality. And you might even call it "Network Neutrality."

Frezza: Yeah, let's re-brand it.

RWT: It's like you're bringing back the exact same thing that squelched innovation at AT&T and saying, let's make this a utility, let's put this in the utility model and enforce the same idea of neutrality or equality.

Frezza: And socialists are always going to support central planning and Network Neutrality. It breaks my heart when the sort of left-liberal libertarians have been bamboozled by the network equality language because they don't know their history. They don't understand that progress requires inequality. If you don't give entrepreneurs the ability to become unequal--not just get rich themselves, the profit motive, but they have to make their customers unequal, they've got to give their customers commercial advantage or life advantage by paying them money. That's what drives progress. If you take that out of the equation, if you say all traffic has to be treated equal, all costumers have to be treated equal--first of all, capital investment in the network is gonna go down. We've already seen some of that. But so is innovation. Why would you want to give that up?

RWT: It's the inequality and the early adopters who have the extra money to spend who allow you to create a lot of companies fast, to have some of them fail, to take those risks and to do things one a small scale before you build it out.

Frezza: And the socialists argue, well, you're arguing that trickle-down is going to solve the problem. And I'm saying, exactly right. Trickle-down worked in the PC business. People used to talk about the haves and the have-nots in the PC biz. You don't hear that anymore. Anybody that wants has a PC, it's the cheapest thing in the world. Same with Internet access. Now, some people have faster Internet access than others. OK. Give it time. If you put enough time and money into it, things always get cheaper in competitive markets.

RWT: I'm going to pick your brain about how to get a decent Internet connection in a rural location, but that's...

Frezza: The answer to that's going to be wireless.

RWT: Well that's actually what I've--I just switched over from a satellite Internet, which is not broadband, to basically using a cell phone signal for the Internet, which is better. I still have data limits, so that I can't do streaming TV without killing my data limits,

Frezza: There's a whole set of technologies called millimeter wave technologies. They're already--they're with pencil-beam connections--that are already hitting the cities. I'm a Webpass customer. I get 400 megabits per second for 50 bucks a month. Bidirectional, by the way. All right, now you have to be in my building, if you're in the building across the street, you don't have access to it yet until they put it on your roof. But we need a thousand flowers to bloom, whether it's cable, whether it's...

RWT: So we need you to be able to have that at your nice little posh building in Boston, whereas me sitting out on the farm in Virginia...

Frezza: You'll get it later. You'll get it later. It will come. You'll never get it if you have universal service from day one.

RWT: Exactly. So how is it that Network Neutrality became such an, almost, object of faith.

Frezza: Well, it's an unholy alliance between central planners and a couple of big crony capitalists like Netflix and Amazon who want a free ride. They're putting a disproportionate amount of traffic on the network, and they don't want to have to pay for it. So they figure, let's get everybody to pay for it. And that's the problem. They're the ones with the lobbyists, they're the ones who could afford the PR people, they're the ones who can write the white papers, and they've bamboozled a lot of people. Not only have they been bamboozled, but Network Neutrality is Title II's nose under the tent. And luckily we've had a change of administration.

RWT: Title II is basically the utility style regulation.

Frezza: Right, utility style regulation, public utility commissions. It's a hop, skip, and a jump to setting rates again, instead of letting the price discovery and the free market process set rates again. And then we're back to where we were under Theodore Vail.

RWT: And I think part of what drives that, too, is the fact that Silicon Valley is full of a bunch of young people who'd have no recollection of what happened before the Internet and how things worked back then.

Frezza: Listen. Listen to the stories. Talk to your elders. This is still living history, there are enough of us who are still alive when it was illegal to own your own telephone, so we don't make the same mistake.

RWT: Well, thanks for spreading that message and helping to make them aware of that history.

Frezza: Rob, thanks for having me.