powerful as to take possession of southern lands through a form of foreclosure. Nor did the national banking system pre- vent major banking and economic crises thereafter. Still, the system worked well enough that it was not replaced until 1913 when Congress passed the Federal Reserve Act. The Federal Reserve System, 1913 to 1933 As the United States experienced what seemed to be uncon- trollable financial panics and economic depressions, frustra- tion with America’s financial system intensified. The depres- sion of the 1890s was especially severe in its impact on unemployment, prices, and economic productivity. Scarcity of currency became a serious problem, as businessmen sought to protect themselves against economic uncertainty by withdrawing their funds from banks. Bank suspensions commonly ensued until Congress passed the Aldrich- Vreeland Act of 1908 that provided for the organization of national currency associations. The law also set up a National Monetary Commission to study the currency problem. It was through such studies that Congress finally acted in 1913 to create the Federal Reserve System. (The legislation appears in the Documents section of this volume.) Originally, the Federal Reserve (the Fed) divided the United States into 12 regional districts with a Federal Reserve Bank in each. Headed by a Federal Reserve Board, the system was controlled by the member banks, with some, such as the New York Federal Reserve, exerting significant authority and influence. The system was particularly attractive because member banks would regulate each other and had authority to issue Federal Reserve notes that would serve as a national currency. Undoubtedly, this arrangement was a major im- provement over what existed before. Between the time of its founding and the outbreak of the Great Depression in 1929, the Fed made a decent showing. It did fairly well during World War I in stabilizing economic ac- tivity and government borrowing. Between 1923 and 1929, the Fed also used open market operations, discount rate changes, and reserve limits to stabilize the growing economy of the decade. Problems, however, soon appeared when the stock market embarked on a highly speculative bull run. To day, most economic historians agree that the Fed stood by and did practically nothing to stave off the impending catas- trophe. The inevitable result was that the U.S. economy, through a convergence of several factors, began to decline rapidly, and the U.S. banking system eventually fell so low that total disintegration was on the horizon. Bank insolven- cies were so widespread by 1932 that state governors were closing banks whether or not they thought they had the au- thority to do so. Herbert Hoover attempted to help the econ- omy recover through such programs as the Reconstruction Finance Corporation, but these efforts were too feeble. By 1932 the American people wanted a change, and they gave a mandate to the governor of New York, Franklin D. Roosevelt, who promised them a New Deal if he was elected. Banking in the New Deal The New Deal was a haphazard and multifaceted attempt, at times successful, to address the Great Depression, but it would fail in the end to alleviate the economic distress. Nev- ertheless, it brought significant reform to the U.S. banking system. No sooner did Roosevelt take the oath of office in 1933 than he immediately closed all the banks for a four-day period with his famous “bank holiday,” when bank opera- tions were suspended until authorities examined them for sound banking practices. Congress soon gave the president the authority he needed by passing the Emergency Banking Act of 1933. More important, Roosevelt acted quickly to seize the opportunity presented to him and endorsed the Glass- Steagall Banking Act of 1933. Considered today as among the most important pieces of legislation affecting U.S. banking, Glass-Steagall created the Federal Deposit Insurance Corpo- ration (FDIC); separated commercial and investment bank- ing; and implemented the well-known Regulation Q of the Federal Reserve Act, which strictly regulated interest rate ceil- ings and remained in effect until 1986. Nor was this the end of the New Deal’s banking reform. Realizing that the Fed must bear some responsibility for the Great Depression and the banking crisis, Roosevelt, in the person of his adviser Marriner Eccles, persuaded Congress to pass the Banking Act of 1935. This law eliminated the origi- nal Federal Reserve Board and replaced it with the Board of Governors. It also centralized all authority in the Board of Governors, thereby reducing the power of member banks. The Fed was definitely now becoming and acting like Amer- ica’s third central bank. Although these reforms were positive advances in the banking industry, they did not necessarily resolve all eco- nomic and banking problems. For example, there was the 1937–1938 recession, which was brought on by Roosevelt’s policies and programs and the use of deficit spending to pro- vide relief for individuals. If nothing else, the recession showed that still more change was needed. During World War II, the Fed helped the federal govern- ment by agreeing to buy government securities in order to maintain the interest rate that the government paid on its debt. This practice remained in existence until 1952 when the Fed stopped buying government bonds. During the Eisen- hower presidency, moreover, the Fed ceased intervening in the economy to maintain a governmentally favorable interest rate.Politically, Fed leaders and U.S. presidents would con- stantly battle each other as each financial crisis occurred, often with the political leaders demanding that the Fed bail them out. American Banking since 1945 After World War II, U.S. banking was definitely influenced by the Fed and by the numerous regulatory laws passed by Con- gress. During the 1950s, the Fed concentrated its attention on inflation control; in the 1960s, it focused more on monetary policy decisions in money market strategies. The Fed itself underwent internal changes, as professional economists began to sit on the board or serve as chairman of the Board of Governors, with Alan Greenspan ultimately becoming one of the longest-reigning Fed chairmen. Throughout the 1970s–1990s period, the Fed advanced in power, influence, and authority. As the economy grew and underwent its own 342 Banking: Development and Regulation Banking: Development and Regulation 343 internal changes—for example, the appearance of the military-industrial complex, the Vietnam War, the Reagan supply-side revolution—the Fed had to adjust not only to economic events but to political changes as well. Slowly and gradually, the Fed ascended to such a level that today it con- trols America’s money supply and economy. These events do not mean that all has gone well for Amer- ican banking and America’s third central bank. Witness the serious economic crises that have erupted since 1960 alone— the Penn Central Railroad crisis (1970), the Franklin Na- tional Bank crisis (1974), the Hunt brothers silver speculation of the 1980s, the stock market crash of 1987, the savings and loan debacle of the 1980s, and the 1990s stock market–Dow Jones problems, many of these attributable to the dot-com bust and the corruption uncovered in corporate America. Yet it is significant that as financial crises have occurred, the U.S. banking system and the Fed have responded, often in very satisfactory ways. After 1945 banking regulation became more focused on very specific issues. In 1956 the Bank Holding Company Act was passed prohibiting interstate acquisitions by banks unless the state approved them. Five years later, in 1961, Congress passed the Interest Rate Adjustment Act that sought to extend Regulation Q to the thrift industry. In 1970 the Bank Hold- ing Company Act was extended to place restrictions on bank holding companies. The 1980s and 1990s brought some of the most significant banking legislation Congress ever en- acted. In 1980 the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) was passed phasing out interest rate regulations and giving the Fed authority over re- serve requirements for practically all banking institutions. All banks and thrifts could participate and use Fed services for a fee, and FDIC insurance was increased. Two years later, Con- gress passed the Garn–St. Germain Act that permitted money market accounts and allowed interstate mergers among banks. One year later, in 1983, the International Lending Su- pervisory Act gave regulatory agencies the authority to estab- lish capital requirements for banks. In 1989 the Financial In- stitutions Reform, Recovery, and Enforcement Act restructured the FDIC and increased insurance premiums. Two years later, in 1991, the Federal Deposit Insurance Cor- poration Improvement Act gave the FDIC the authority to monitor troubled banks. Still more was to come. In 1999, Congress passed and President William Clinton signed into law the Financial Services Modernization Act. Comprehensive in scope and intent, the law removed restric- tions on banks affiliating with securities firms, created a new “financial holding company,” provided for state regulation of insurance, streamlined governmental restrictions on bank holding companies generally, and included a host of other re- forms governing savings and loans and other financial inter- mediaries. If nothing else, these regulatory pieces of legisla- tion show that the federal government actively watches over and is involved in America’s growing and massive banking system. Banking Today To day, American banking faces new problems and challenges. Undoubtedly, one of the most significant developments is the growing consolidation of banks throughout the nation, and especially in regions such as the South. The small hometown bank, once the norm across the American heartland, is be- coming a relic of the past. Similarly, Americans are facing new ways of banking with automatic teller machines (ATMs) and “smart” cards that not only store personal information but also work as phone cards, charge cards, debit cards, and elec- tronic cash repositories. Online banking is becoming increas- ingly popular as banks seek to cut costs and increase profit margins and find that customers like the convenience. Fi- nally, the possibility of e-money—electronic money that al- lows the transfer of funds electronically—however contro- versial, is becoming reality. If U.S. banking follows its historical past, it will readily ad- just to such changing conditions. In addition, the Fed will continue its important role in control of America’s financial intermediation system. —Michael V. Namarato References Blackford, Mansel, and Austin Kerr. Business Enterprise in American History. 2d ed. New York: Houghton Mifflin, 1990. Carosso, Vincent P. Investment Banking in America: A History. Cambridge, MA: Harvard University Press, 1970. Fogel, Robert William, and Stanley Engerman, eds. A Reinterpretation of American Economic History. New Yo rk:Harper and Row, 1971. Friedman, Milton, and Anna J. Schwartz. A Monetary History of the United States, 1867–1960. Princeton, NJ: Princeton University Press, 1963. Galbraith, John Kenneth. The Great Crash, 1929. Boston: Houghton Mifflin, 1972. Hammond, Bray. Banks and Politics in America from the Revolution to the Civil War. Princeton, NJ: Princeton University Press, 1957. Kindleberger, Charles. Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books, 1978. Krooss, Herman, and Martin Blyn. A History of Financial Intermediaries. New York: Random House, 1971. Redlich, Fritz. The Molding of American Banking: Men and Ideas. New York: Hafner, 1947 and 1951. Schweikart, Larry. Banking in the American South from the Age of Jackson to Reconstruction. Baton Rouge: Louisiana State University Press, 1988. Stein, Herbert. The Fiscal Revolution in America. Rev. ed. Washington, DC: American Enterprise Institute, 1990. Sylla, Richard. “American Banking and Growth in the Nineteenth Century: A Partial View of the Terrain.” Explorations in Economic History, vol. 9 (1971–1972): 197–227. Te min, Peter. Did Monetary Forces Cause the Great Depression? New York: Norton, 1976. Wicker, Elmus. Federal Reserve and Monetary Policy, 1917–1933. New York: Random House, 1966. Big Business and Government Relationships The adoption of the U.S. Constitution put an end to the prac- tice of states imposing tariffs on one another, a practice that prevented development of the national economy. A robust national economy as envisioned by Alexander Hamilton re- quired a strong centralized government, and the founding fa- thers laid the constitutional groundwork for this national au- thority in article 1, section 8, with enumerated powers granted to Congress. They perceived these powers as indis- pensable for the development of enterprise on a large scale, including the powers to establish a postal system that could unite the nation through communication, to grant copyright protection, and to regulate interstate and foreign commerce; perhaps most important was the power granted exclusively to Congress to coin money. A major argument for adopting the U.S. Constitution involved relief for creditors who had to pay back their loans with inflated state paper money. Business and Government: The Search for Balance There had been efforts to promote economic growth even be- fore the U.S. Constitution was adopted. For example, the Northwest Ordinance of 1787 emphasized public education and development of the intracoastal waterway system that subsidized the barge industry until the late 1970s. The pur- pose of the waterway was to enable the nation to connect commercially and politically, and the ordinance decreed that the waterways would remain forever free. Efforts to impose fees on barge operators to defray costs began during the ad- ministration of Franklin D. Roosevelt but did not succeed until Jimmy Carter’s presidency, even though the policy change had the support of all intervening presidents. In addi- tion, the ordinance provided that the U.S. government would turn over large tracts of land to territories on the condition that they establish public schools. Another measure dealing with education was the Morrill Act (1862), a more explicitly economically oriented measure authored by Republican U.S. Senator Justin Morrill of Ver- mont. The act provided land grants for the establishment of agricultural and mechanical colleges (which came to be known as A&M schools). The government also participated in the development of railroads, granting the railroad industry huge land subsidies to foster its growth. Indeed, the Republican Party in the nine- teenth century, including President Abraham Lincoln and U.S. Senator Leland Stanford of California, promoted such subsidies. The aftermath of the Civil War brought continued expansion of the railroads and of other industry in general. Opinion about government involvement was not uniform, however. In the second half of the nineteenth century, debate surrounded the opposing views held by big business and small farmers about the desirability of national government activism. Initially, monied interests saw a strong national gov- ernment as overwhelmingly desirable, since the U.S. Treasury paid creditors in hard currency, Congress imposed high tar- iffs on foreign goods to diminish potentially fatal competi- tion, and the government established a strong national bank. In contrast, the typical small yeoman farmer initially saw few advantages and many disadvantages in a strong national gov- ernment, especially after small farmers became dependent on the railroads and grain elevator operators. In an about-face, however, the farmers ultimately sought federal regulation of these businesses that held exploitative power over the small enterprises, which remained no match for the railroads or any other big business. As Adam Smith concluded in The Wealth of Nations (1776), the last thing anyone in business wants is competi- tion. The “invisible hand” of competition might produce the greatest good for the greatest number, but collusion is attrac- tive to most people. With this realization in mind, Congress passed the Sherman Anti-Trust Act of 1890, but the U.S. Supreme Court considerably weakened the act in two famous cases. In the first, the Court held that manufacturing trusts were not engaged in commerce and, therefore, could be regulated only by the states (United States v. E. C. Knight Co., 156 U.S. 1 [1895]). In the second, the Court laid down the “rule of reason” by which not every combination in restraint of trade (as Congress had 344 explicitly stated in the Act) was illegal, but only those unreasonably so (Standard Oil Co. v. United States, 221 U.S. 1 [1910]).(Plano and Greenberg 2002, 518; emphasis added) To overcome these rulings that weakened the act, Congress passed the Clayton Act of 1914. Still, until 1937 the Supreme Court continued to act as defender of the status quo by find- ing unconstitutional statutes intended to ameliorate the worst effects of industrialization, as it did with its holding in Hammer v. Dagenhart that voided a statute prohibiting child labor. Although the judiciary lagged in its response to the un- desirable side-effects of industrialization, such as sweatshops and unsanitary conditions as depicted in Upton Sinclair’s The Jungle, the executive branch during the administration of President Theodore Roosevelt became activist, undertaking antitrust actions and promoting such measures as the Pure Food and Drug Act and the Meat Inspection Act. Other administrations were activist to some degree until the 1920s. President William Howard Taft pursued trust- busting with even more fervor than Theodore Roosevelt had exhibited. President Woodrow Wilson signed the Clayton Act of 1914, which forbade abuses that tended to weaken compe- tition, restricted corporations from acquiring stock in com- peting firms or building interlocking directorates, made cor- porate officers individually liable for violations, and facilitated civil suit procedures by injured parties. Subsequently, Presi- dents Warren G. Harding and Calvin Coolidge heralded, re- spectively, “a return to normalcy” and “that the business of America is business.” During the “roaring twenties” in indus- trialized America, stock market speculation soared, and the policy of laissez-faire held sway during President Coolidge’s tenure. Although conditions appeared robust in the realm of big business, by the mid-1920s depression had already descended upon the farms. When the stock market crashed in October 1929 heralding economic decline in the industrial sector, the lessons learned by policymakers from the last depression of the nineteenth century appeared inapplicable to the current crisis. Clement Studebaker, president of the Studebaker Cor- poration, and many others blamed President Herbert Hoover for causing the depression by lowering tariff duties. Conse- quently, Congress responded initially to the Great Depression by passing the Hawley-Smoot Tariff Act of 1930, which raised the average tariff duty to approximately 60 percent and pro- voked retaliatory actions from other nations. The legislation has since been cited as having deepened the Great Depression. Approaches to trade remained a major point of con- tention among government policymakers over positions taken with respect to the General Agreement on Tariffs and Tr ade (GATT). This is evident in the excerpts reprinted here from letters written in December 1994 by Democratic U.S. Senator J. Bennett Johnston Jr. and Democratic U.S. Repre- sentative Jimmy Hayes, both of Louisiana. Political scientist David B. Truman explained in a 1956 article in the American Political Science Review that party identification and state of residence accounted for most of the variation in how mem- bers of a congressional delegation voted. Yet these excerpts offer quite different perspectives on GATT. (A side note is that about a year after the these letters were written, Jimmy Hayes switched his membership to the Republican Party and subsequently ran unsuccessfully for the U.S. Senate seat, which J. Bennett Johnston Jr. had vacated.) U.S. Senator J. Bennett Johnston Jr. wrote the following on December 12, 1994 (letter to author): Thank you for contacting me to express your thoughts on the GATT legislation. I joined Presidents Reagan, Bush and Clinton in supporting GATT. I voted for it because it will greatly benefit the economy of the United States in general and Louisiana, in particular. GATT will promote sales of Louisiana’s agricultural commodities and chemicals, and will enable smaller manufacturers to break into foreign markets. Louisiana is a trade state. We have more ports and exports per capita than any state in the nation. They are the source of thousands of Louisiana jobs. We are in a strategic location to ship the increased cargo that will result from GATT from across the United States to overseas markets. U.S. Representative Jimmy Hayes expressed concerns in a let- ter written December 7, 1994, that led him to vote against GATT. He stated that he opposed the fast-track procedure in principle, I could not support the attachment of completely unrelated (and potentially destructive) provisions. I was also concerned about the dispute resolution process. Under the proposal, the United States will have the power to enforce fair-trading practices on offending countries, while losing our power to block decisions made against our trading practices. Without blocking power, the United States could suffer trade penalties from those countries disputing our trading practices unless we change our laws to suit their demands. The Regulatory Cycle The interrelationship between the U.S. government and big business in international relations became evident when the United States and Britain joined forces in attacking targets in Afghanistan on October 7, 2001, in the aftermath of attacks on the World Trade Center in New York City. The twin tow- ers housed thousands of employees of big businesses, includ- ing Morgan Stanley. The terrorists also provoked retaliatory attacks by targeting the Pentagon. War has commonly resulted in increased collaboration be- tween business leaders and government. Business leaders played a role in planning U.S. deployments in both World War I and World War II. Charles Erwin “Engine Charlie”Wil- son left his position as president of General Motors to serve as U.S. Secretary of Defense in the Eisenhower administra- tion, during which legislation beneficial to big business was Big Business and Government Relationships 345 passed, including the Interstate Highway and Defense Act of 1956. In addition, Robert S. McNamara, taking with him a number of other “whiz kids,” moved from the Ford Motor Company into the position of U.S. Secretary of Defense dur- ing the Kennedy and Johnson administrations. The prominence of automobile executives in the Defense Department was unsurprising, since automobile factories manufactured Jeeps, aircraft, and tanks during World War II. Some government policies tremendously benefited the auto- mobile industry, such as the construction of the U.S. and in- terstate highway systems, but others threatened corporate profits. General Motors, in its 1979 annual report, com- plained that its net income had fallen to only 4.4 percent, whereas in 1965 profits had reached 10.3 percent. From its perspective, the government had to reduce spending, regula- tion, and the size of the national deficit. Interestingly, regula- tion of the automobile industry, at least as it applied to auto- mobile safety, occurred as the result of actions taken by General Motors in 1965. In 1956, Ford Motor Company in- troduced a deep-dish steering wheel that allegedly was less likely to crush a driver’s chest in the event of an accident, but no profits to the company clearly resulted. In ensuing years, a Democratic congressman from Alabama studied automobile safety yet made relatively little headway. But in 1965 an ob- scure lawyer named Ralph Nader published Unsafe at any Speed. The book lambasted automobile manufacturers for their lack of emphasis on safety, as evidenced by the produc- tion of hardtops, cars lacking center roof pillars, which crushed easily during rollovers. Nader also identified one ve- hicle not sold in a hardtop version, the rear-engine Chevrolet Corvair, that rolled over easily due to a weak rear axle design. General Motors responded by hiring private detectives to in- vestigate Nader’s personal life. This grotesque invasion of his privacy made Nader a household name and led to his testify- ing before a transportation safety committee chaired by De- mocratic U.S. Senator Abraham Ribicoff of Connecticut. Fol- lowing lengthy testimony that included a grisly X-ray photograph of a boy with a 1951 Mercury hood ornament embedded in his skull, Congress passed the National High- way Traffic Safety Act of 1965. Regulation hit its peak during the administration of Richard M. Nixon when Congress established the Environ- mental Protection Agency, the Occupational Safety and Health Administration, and the Consumer Product Safety Commission. Later in the 1970s President Jimmy Carter began working for deregulation. Americans placed great em- phasis on airline deregulation, and Clinton economist ap- pointee Alfred Kahn led the charge. Efforts also ensued to deregulate financial institutions, particularly the savings and loan industry, and this activity accelerated during the admin- istration of Ronald W. Reagan. Indeed, whereas Carter be- lieved in the goals of most regulations (though he thought Americans could pursue them in a more parsimonious and efficient manner), President Reagan thought most regulatory objectives had dubious value. J. Brooks Flippen noted the fol- lowing (Flippen 2000, 232): Maintaining that government bureaucracy stifled America, Reagan used the Office of Management and Budget to drain power from regulatory agencies. EPA was hit particularly hard, deprived of 29 percent of its budget and a quarter of its staff in the first two years of the administration. Innovative programs in such areas as solar energy and alternative fuels faced complete emasculation. Although public reaction remained negative toward weak- ening environmental protection, efforts that began during the Carter administration and accelerated during the Reagan administration helped to deregulate the savings and loan in- dustry. Eventually, many of the savings and loan associations failed in the aftermath of deregulation changes, with hun- dreds of billions of taxpayers’ dollars required to ameliorate the meltdown. The deficit reduction called for in the 1979 annual report of General Motors did not appear for two decades. During the first Reagan administration, the deficit quadrupled. Not until twenty years later would the nation’s budget, in the words of President Bill Clinton, “be balanced, for the first time in a generation.” Big business remained a prominent feature of life in the United States in the late nineteenth and twentieth centuries. This trend will certainly continue in the twenty-first century. Big-business executives in the United States remain highly compensated. Compared with income of the average wage earner in terms of dollars, compensation for today’s execu- tives exceeds that of their U.S. counterparts from centuries past as well as that of their peers in other nations. —Henry B. Sirgo References Critchlow, Donald T. Studebaker: The Life and Death of an American Corporation. Bloomington: Indiana University Press, 1996. “Economic Report of the President.” Washington, DC: U.S. Government Printing Office, 1999. Flippen, J. Brooks. Nixon and the Environment. Albuquerque: University of New Mexico Press, 2000. Hayes, Jimmy, to author. Letter in possession of author. December 7, 1994. Johnston, J. Bennett, to author. Letter in possession of author. December 12, 1994. Niemark, Marilyn Kleinberg. The Hidden Dimensions of Annual Reports: Sixty Years of Social Conflict at General Motors. Princeton, NJ: Markus Wiener, 1995. Plano, Jack C., and Milton Greenberg. The American Political Dictionary. 11th ed. Fort Worth, TX: Harcourt College Publishers, 2002. Reid, T.R.Congressional Odyssey: The Saga of a Senate Bill. San Francisco: W. H. Freeman, 1980. 346 Big Business and Government Relationships Communications 347 Recognizing the importance of communications among citi- zens of the newly formed United States, the Continental Con- gress appointed Benjamin Franklin the country’s first post- master general in 1775. In the eighteenth century, letters were the primary means of communication for those separated by space, and the country’s founders realized that timely deliv- ery of mail would help to bind the new nation together, facil- itate commerce, and encourage the flow of ideas and infor- mation. In making mail service the responsibility of the federal government, these officials implicitly recognized that private markets were unlikely to generate optimal outcomes in the provision of this communication service. From an economic perspective, an industry generates maximum social benefits if production expands until the cost of producing one more unit of output just equals the benefit derived from producing that additional unit. Further, all costs of production are incurred by the producer, so no external costs fall on those not privy to the decision to produce the good or service in question. All benefits of production fall to the consumers who purchase the product; thus, those not privy to the decision to purchase recognize no external bene- fits. In other words, costs and benefits are private. Theoretical analysis suggests that competitive markets generate, via the self-interest of the producing and consuming parties, an out- come whereby the net social benefits of production are max- imized. Economic efficiency exists in that there is no dead- weight loss—that is, there is no difference between the maximum net social benefits and the actual net benefits gen- erated by the industry outcome. This conclusion—the opti- mality of competitive outcomes—holds only for perfect competition in static contexts with no spillover (additional) effects or externalities (external, uncontrolled) effects. Such ideal conditions are unlikely to be met by any real-world markets, of course. But in many cases, actual conditions are close enough to this ideal and the difficulties of attempting any effective public policy intervention are pervasive enough that relatively unregulated markets—which bring together private buyers and sellers—function reasonably well in allo- cating society’s scarce resources. Historically, three conditions particular to the communi- cations industry have seemed sufficiently far from the com- petitive ideal to warrant intervention. Although those condi- tions especially apply to telecommunications, they arguably typify mail communications as well. First, the industry exhibits network effects. With network effects, externalities occur because of interdependent de- mands. For instance, the benefit that each consumer enjoys from using telephone service depends upon the number of other people using that service: A single subscriber to a tele- phone service would obtain no benefit (other than status per- haps) without being able to call others. But with network ef- fects, all consumers benefit by interconnectivity, so that each consumer can reach every other consumer. This interconnec- tivity does not necessarily require that the service be offered by only one provider, but it does require that different providers use compatible equipment—in essence, that there be a single, networkwide standard. Network effects also pro- vide an efficiency rationale for universal service. A second condition warranting intervention stems from economies of scale, which occur when a proportional in- crease of all inputs raises output by a greater proportion. When economies of scale are extensive relative to market de- mand, a single firm can supply the market at a lower cost per unit of output than can multiple firms. Competition is un- likely to exist as a dominant firm expands to take advantage of the lower average costs that come with high output. The third condition occurs with economies of scope, when more than a single product or service is produced. Te lecommunications firms, for example, produce multiple services, such as long-distance and local calling. With economies of scope, a firm can produce a given quantity of both services at a lower total cost than could two firms, each specializing in the production of one of the services. Given the existence of these three conditions, modern public policymakers have deemed that telecommunications is likely to be monopolistic or even a natural monopoly (which controls the market through increased efficiency in the industry). Eighteenth-century public policy makers came 348 Communications to a similar conclusion about mail service. Believing that the private delivery of mail would probably not generate as much service as was socially desirable, they set up a public firm to handle this responsibility. Te c hnological change dramatically altered the delivery of communications services in the two centuries following Franklin’s appointment. Public policy has changed, albeit not always smoothly or quickly, in response to this evolving tech- nology, but communications have remained a target for col- lective ownership or oversight and regulation. Postal Service Even before Franklin’s appointment as postmaster general, the North American colonies experimented with both pri- vately and publicly funded mail delivery schemes. During a time when transportation by sea was much cheaper than transportation over land, communication between England and North America dominated colonial mail service. In 1639 Richard Fairbanks’s Boston tavern was named the receiving site for this overseas mail, and it became the location from which colonial distribution emanated. In 1673 the New York governor established a short-lived monthly mail service be- tween New York and Boston, and William Penn set up Penn- sylvania’s first mail service ten years later. The British Crown contracted with a private organization in 1691 to establish central mail delivery and then purchased control of the sys- tem in 1707. In the 1730s, long before his Continental Con- gress appointment, Franklin served as postmaster in Philadelphia under the British system, and he became one of the two joint postmasters general for the British in the colonies. Under his leadership, the postal service reported its first surplus in 1760. After Franklin was dismissed in 1763, Postmaster William Goddard instituted the Constitutional Post to provide mail service among the colonies, with the funding obtained by subscription and revenues used to im- prove the services offered. When the colonies revolted, Franklin chaired the Committee of Investigation to formu- late a mail system. Under the 1781 Articles of Confederation, Congress had the sole right to create and regulate post offices. Initially letter recipients paid the postage costs, but in 1847 the post office issued stamps purchased by the senders of mail. Facing little or no competition in providing communica- tions, the postal service grew with the new country, and new technology complemented this service. In 1832 the postal service entered into tentative contracts for transporting cor- respondence by rail. An 1838 act designated all U.S. railroad routes as postal routes; soon postal agents accompanied the mail on the rails, and 1862 witnessed the first post office on wheels. The westward movement of the railroad preempted a brief but memorable effort at an express, horse-based mail service between St. Joseph, Missouri, and California. The Pony Express operated between April 1860 and October 1861, when telegraph lines reached the West Coast. In 1911, with the development of air transportation, the postal service began to ship mail by plane. The public provision of mail service was partly motivated by considerations of economic efficiency. The political inter- est in tying the country together also encouraged this service. Concerns about fairness likely affected post office decisions about rates and interacted with the goal of providing univer- sal service. The postal service introduced free city delivery in 1863, the same year that it established uniform postage rates within the country, regardless of distance. Rural free delivery followed 29 years later. During Andrew Jackson’s administration, the postal serv- ice attained Cabinet status, but the 1970 Postal Reorganiza- tion Act, motivated by large deficits in the post office budget, removed the service from the Cabinet and streamlined its op- erations. Te legraph Service The application of electricity to communications was de- scribed at least as early as 1753, with published suggestions for an electric telegraph. The early-nineteenth-century devel- opment of the electrochemical battery and the discovery of the relationship between magnetism and electricity led the way to a working prototype, which Samuel Morse demon- strated in 1837. Like the postal service, the telegraph industry would make use of the railroads, for telegraph lines could be strung along the right-of-way for the rail lines’ roadbeds. The first workable telegraph line of significant distance was strung for 40 miles along the Baltimore and Ohio Railroad tracks between Baltimore and Washington, D.C., in 1844. The usefulness of telegraphy, especially when vast distances sepa- rated people and activities, led to its rapid adoption, and in less than 20 years from their initial commercial use, telegraphs lines connected the Atlantic and Pacific Coasts. By the end of the American Civil War, international telegraph service linked the United States with Europe. The telegraph industry displayed at least some of the at- tributes of a natural monopoly. Most European countries set up government-owned monopolies to provide telegraph service, and they restricted entry into the industry, just as they would do for telephone service. But in the United States, policymakers instead were confronted with a private monop- oly when the many competing companies merged into the Western Union Telegraph Company in 1865. The lively minds of nineteenth-century scientists fasci- nated by electricity developed the basic elements of the writ- ing telegraph, a rudimentary facsimile machine. The scientists also experimented with wireless electrical communication systems. Successful commercial applications of these tech- nologies did not emerge until well into the twentieth century. Te lephone Service In the 1974 antitrust case brought by the U.S. Department of Justice against American Telephone and Telegraph (AT&T), the company argued that the regulated monopoly structure of the U.S. telephone industry had served consumers well. AT&T’s defense rested upon its contention that telephone service, as a network industry, worked best when a single firm connected all consumers, handled both local and long- distance calls, provided equipment of the necessary quality 348 Communications 349 and compatibility, and developed new equipment and serv- ices for the future. Hence, the company contended, the ver- tically integrated structure of the telephone industry—with a single company controlling equipment manufacture (through Western Electric), providing long-distance service (through long lines), interconnecting with local operating companies (through wholly owned operating subsidiaries), and undertaking research (through Bell Laboratories)— generated good outcomes. It gave consumers one-stop shop- ping for telephone service, at prices that made local service almost universal, and it compared favorably with the state- owned monopoly telephone companies common in most other countries of the world. In contrast, the Antitrust Division of the Justice Depart- ment contended that AT&T had used its position to monop- olize the industry in violation of the Sherman Anti-Trust Act and to forestall potential competitors’ entry into the field. Eight years later, in 1982, the parties settled the case via a consent decree, issuing the modified final judgment that re- sulted in the largest divestiture in antitrust history and the breakup of the Bell system. As the new millennium dawned, the consequences of this breakup, the effects in the United States of a new telecommunications law, and the forces of changing technology were continuing to modify the struc- ture of the telecommunications industry, and few commen- tators have been brave enough to predict the future of that structure. Like past policy, future uncertainty results from the economic characteristics of the industry, the history of policy in the field, and the rapid technological changes of the last half century. Economic Characteristics of the Telephone Industry Because the telecommunications industry exhibits network effects and because economies of scale and scope occur in production, perfectly competitive markets are unlikely to exist in this field. In some countries, policymakers have re- sponded to the failure of the private market in telephony by providing the service publicly, thereby substituting public monopoly for private monopoly. In other nations, most no- tably the United States, policymakers have severely limited entry into the industry by granting a single franchise to a pri- vate provider of telecommunications services and then regu- lating that supplier, presumably to protect consumer inter- ests. As technological change occurred during and after Wo rld War II, the relationship of effective telecommunica- tions to military policy added a defense concern to the policy goals. Whatever the benefits or costs of past public policy, evolving telecommunications technology during the last half century has led to pressures for policy change. History of the Telephone Industry in the United States In 1876 and 1877 Alexander Graham Bell received patents on basic telephone equipment, besting Elisha Gray’s similar patent filing. Bell offered to sell his patent rights to Western Union for $100,000, an offer that was refused. Western Union soon attempted to enter the telephone industry on its own, using equipment developed by the Thomas Edison labs. The new manager of the Boston Bell Patent Associa- tion, Theodore Vail, forced Western Union to back out of the telephone field by threatening to sue for patent infringe- ment. The American Bell Company made money by assign- ing exclusive franchises to companies in separate geographic areas, taking an equity stake in each. Bell purchased Western Electric, the equipment manufacturer, in 1881 and four years later established a toll company, the long lines that con- nected the local Bell operating companies. Thus, by the time that the original Bell patents expired in 1893 and 1894, the vertically integrated structure of the Bell system was in place. The now public American Bell Company faced competi- tors that were attracted to the industry by the company’s high profits even before Bell’s patents expired—and despite its practices designed to control the market. For example, Bell required customers to lease all telephone equipment from the company. It also refused to provide interconnection for competitors to its long-distance service; thus, customers who wanted such service and non-Bell local service had to have two telephones. In addition, the company proceeded to buy up its competitors. Its increasing dominance of the te- lephony industry as the twentieth century dawned may have resulted from economies of scale and scope and efficiencies derived from central control of the network. The dominance may also have stemmed, however, from deliberate strategies to drive efficient competitors from the field through preda- tory pricing, financial market connections, and manipula- tion of the regulatory environment. Through its ownership of the Empire Subway Company in New York City, for in- stance, AT&T refused its potential local-service competitors access to underground conduits. It also agreed to limit its entry into telegraphy in return for Western Union’s commit- ment not to lease pole space to telephone competitors. De- spite such efforts, however, independents did manage to es- tablish local companies, especially in the Midwest, and they also set up regional networks. Some contend that, in re- sponse, AT&T strategically set prices below the average vari- able cost in local markets, using profits from its monopo- lized markets to subsidize short-term losses in its competitive markets. This predatory pricing hurt the com- petition, deterred potential competitors, and reduced buy- out prices. The regional independents had neither AT&T’s profits from monopolized markets nor the company’s access to New York financial markets to sustain their own short- term losses. The panic of 1907 further exacerbated the fi- nancial problems of the independents. To avoid scrutiny of its purchases of rival operations in terms of antitrust violations, AT&T sometimes used third parties to make acquisitions on its behalf. For example, in 1909, AT&T provided the R. L. Day Company $7.3 million to purchase the United States Company, a midwestern inde- pendent whose assets were valued at almost $13 million. The only legal action that AT&T faced from its operations in competition with the United States Company came from minority stockholders in Central Union, AT&T’s regional operating company. In the 1909 case Read et al. v. Central Union, these individuals filed suit against the majority stock- holders when Central Union consistently incurred losses in 349 its attempt to drive the independent firm from the market. The judge in the case ruled that Central Union’s predatory actions had harmed the plaintiffs, and he ordered AT&T to sell its holdings in the company. Before this judgment could be effected, however, the parties settled out of court, with AT&T purchasing the minority shares at prices well above market value and par value (the amount paid to the investor at maturity). AT&T also took advantage of state regulations to enter local markets on more favorable terms than the incumbents (companies already in the market) faced and to deny its com- petitors access to valuable facilities. For example, as a precon- dition for entry into the local market, New York required companies to offer long-distance connections to all cities within 1,000 miles that had more than 4,000 residents and to present contracts providing this service within six months of receiving a New York franchise. By 1910 AT&T, under the leadership of Theodore Vail (who had resigned from the company in the 1880s but re- turned early in the twentieth century), had consolidated its hold on the telephone industry. Economic historians note that during the competitive period following patent expira- tion and lasting roughly until 1910, telephone connections grew at an annual rate of 20.6 percent, as compared with 3 percent to 5 percent in the preceding and succeeding years. They point out that in 1920, only 35 percent of all households had telephones and that both the proportion and the num- ber of farms having phones fell in the 1920s and 1930s. Foreshadowing current debates about the relationship be- tween telecommunications and broadcasting via broadband, AT&T briefly maintained interests in radio broadcasting after Wo rld War I. Italian scientist Guglielmo Marconi’s experi- ments with radio waves in the early twentieth century led to commercial radio. The Pittsburgh-based Westinghouse Company, through its radio station KDKA, used amplitude modulation in 1920 for the first U.S. public broadcast. Several other companies, including AT&T, soon set up their own sta- tions. AT&T’s radio station, WEAF, began broadcasting from New York in 1922. Westinghouse and General Electric (GE) had established the Radio Corporation of America (RCA) as a patent-holding company, and in 1926, AT&T agreed to sell its interests in radio broadcasting to RCA. Regulation of the Telecommunications Industry Antitrust policy seeks to promote greater competition and the gains associated with it by prohibiting monopoly and specific practices considered likely to lead to monopoly. Eng- lish common law long proscribed monopoly, but passage of the Sherman Anti-Trust Act in 1890 formally codified the federal position toward market control in the United States. When competitive markets are deemed unlikely to exist or unlikely to function in the interest of consumers, the U.S. policy response has been to limit entry into the affected in- dustry, to grant a franchise permitting entry to the successful applicant(s), and then to regulate the behavior of the licensed firm. Antitrust actions have been brought numerous times against telephone service providers, especially AT&T, both by private plaintiffs and by the Antitrust Division of the Justice Department. State regulation of telecommunications preceded federal involvement. Several southern states were the first to enact regulations in this field, and perhaps they tried to use low communications rates to entice business investment. In 1907 Wisconsin and New York became regulatory leaders. By 1914 34 states and the District of Columbia were regulating such things as rates, licensing and interconnection requirements, and common-carrier status. Congress promulgated federal regulations with an amendment to the Mann-Elkins Act of 1910, which provided for Interstate Commerce Commission (ICC) oversight of the telephone industry. The postal service had cast a covetous eye toward the industry, agreeing with Vail that it was a natural monopoly. Populists and monopo- lists joined forces to prohibit competition in the industry. Faced with the possibility of a government-owned telephone company, AT&T supported measures to make the industry a regulated monopoly. And with regulation, AT&T became somewhat immunized, at least for a while, from antitrust ac- tions. The federal Willis-Graham Act of 1921 shifted the reg- ulatory oversight of telephone mergers and acquisitions from the Department of Justice to the ICC; as regulator of the tele- phone industry, the ICC primarily reacted to complaints. Economic concerns in the 1930s about problems with hold- ing companies led to the 1934 passage of the Federal Com- munications Commission Act. This legislation set up the agency that would regulate interstate telephony and set the dominant tone of regulation until the 1982 court-mandated breakup of the Bell system and the 1996 Telecommunications Act. The 1934 act further formalized the dual regulation of the telephone industry, with the Federal Communications Commission (FCC) responsible for long-distance service and state (and local) agencies responsible for local service. Be- cause the services were supplied interdependently, with long- distance calls originating and terminating through the access lines of local service providers, the appropriate division of regulatory responsibilities was frequently questioned. A sin- gle company, AT&T, usually provided both local and long- distance services. Although the Bell system initially did not rush to provide service outside major urban areas, it supported the regulatory goal of establishing universal service. To the extent that uni- versal service would take advantage of network effects, it would augment the value of telephone service to all users. In- creasingly, however, universal service came to mean the pro- vision of basic service at “affordable” rates. Regulatory agen- cies typically set rates to cover the costs of production, with a reasonable return on investment included. Although some of the costs of telephony can be attributed to a particular serv- ice, ambiguity exists about how to divide other costs among the services offered. The Bell system, with regulatory over- sight, met the requirement of providing affordable service by charging rates below the cost of production for some serv- ices; it then was permitted to charge rates above the cost of production on other, “nonbasic” services to offset the losses incurred on basic services. Over time, an elaborate system of 350 Communications cross-subsidization arose, with long-distance calls subsidiz- ing local service, business customers subsidizing residential customers, and urban users subsidizing rural users. It is not clear that these subsidies redistributed real income from the rich to the poor, but without doubt they increasingly dis- torted economic decision making. And over time, the regula- tory rate structure probably discouraged the use of the least- cost combination of resources to produce a given level of output. The first public demonstration of microwave technology occurred in 1915, and American and British groups worked on its further development. By 1946 several U.S. firms had sought FCC franchises for microwave telecommunications service in a number of eastern cities. Faced with this chal- lenge, the Bell system undertook a massive R&D effort that would enable it to introduce a nationwide microwave system, which it had readied by 1950. With pressure from AT&T, the FCC excluded all other microwave competition until 1959, thereby transforming this arena of potential competition into an exclusive AT&T monopoly over both transmission and equipment. In 1959 the FCC issued its “above 890 mega- hertz” decision, which granted to private companies the use of that portion of the bandwidth for internal microwave op- erations. Finally, in 1969, the FCC allowed Micro-Wave, Inc. (MCI), after a six-year quest, to enter the long-distance serv- ice market, and it required AT&T to interconnect MCI with local operating companies. Entry into the long-distance mar- ket was particularly attractive because regulation led to high long-distance rates (presumably to subsidize universal local service). It is likely that these high rates unrealistically at- tracted multiple companies to enter the industry. Space exploration led to yet another telecommunications technology. By the end of the 1960s, seven international satel- lites orbited the earth and had the potential to relay telecom- munication signals. The FCC granted a franchised monopoly to Comsat, a mixed private corporation established in 1962, and the company partially succeeded in capturing the U.S. domestic satellite market. (A mixed private corporation is composed of diverse forms of public and private enterprises working together—for example, local police, agents from the Federal Bureau of Investigation [FBI], and Pinkerton detec- tives, all with policing authority.) Given the interest in this market and the political pressure for access to it, a White House initiative in 1970 established a policy that permitted all qualified applicants to send up satellites. Successful entry into the field still required interconnection with the Bell sys- tem, but regulatory moves made this more likely. Antitrust Issues in the Telephone Industry During AT&T’s aggressive pursuit of its competitors in the early twentieth century, a number of independent companies complained to the newly formed Antitrust Division of the Justice Department. Reacting to these complaints, the divi- sion filed suit against AT&T, charging the dominant firm with monopolization. In response, AT&T entered into the so- called Kingsbury Commitment of 1913, agreeing to provide long-distance interconnections to its competitors and prom- ising not to purchase further competitors without regulatory approval. The company also divested itself of Western Union through this agreement. However, AT&T continued to pur- chase noncompeting companies, and the 1921 Willis- Graham Act, which shifted merger oversight to the ICC, fur- ther lessened the constraints on the company’s acquisition of competitors. But before AT&T could acquire 100 percent of the country’s local telephone companies, it once more agreed to restrict additional acquisitions. For their part, the inde- pendents learned that, under regulation, they and the domi- nant firm shared an interest in restricting new entrants into the market, and the remaining independents and AT&T co- existed peacefully until 1982. Although the regulation of telephony reduced the antitrust pressure on AT&T, it did not eliminate it. The vertical integra- tion of telephone research, equipment manufacturing, and local and long-distance service continued to generate con- cerns about possible violations of antitrust laws. In particular, AT&T’s control over the price of telephone-related equipment led to fears that the company was inflating these prices and thereby generating costs that were then built into average cost- regulated prices; thus, for instance, AT&T could shift profits from the telephone service stage to the equipment manufac- turing stage. In 1949, the Antitrust Division filed suit, seeking Bell’s divestiture of Western Electric. Ultimately, the 1956 set- tlement of this case did not require divestiture, but it con- strained AT&T from entering industries other than regulated telecommunications (such as the computer industry), and it further stipulated that the company would produce equip- ment only for its own use and would license its patents for rea- sonable and nondiscriminatory royalties. Further concerns about AT&T’s restrictions on the use of telephone equipment soon arose. As a result of the 1956 case involving the Hush-a-Phone, a device that permitted private conversations in crowded rooms, AT&T had to permit at- tachments to its phone networks. Similarly, the 1968 decision regarding the Carterfone, a device involving a two-way radio system, permitted a coupling device to be attached to a phone in order to connect phone users with radio devices. Eventu- ally, AT&T’s requirement that users of its services had to lease and use only Western Electric equipment to access those serv- ices was eroded. Changing technology further challenged regulatory con- trol of a monopolistically structured telecommunications industry. Many of the challenges occurred through antitrust cases and led to the 1974 case in which the Antitrust Divi- sion again charged AT&T with violation of the Sherman Anti-Trust Act. After years of proceedings, the case was set- tled in 1982 when a modification of final judgment of the 1956 consent decree was issued. Changing technology and the potential for more competition within the telecommu- nications industry had led to the decree and affected its spe- cific requirements. Technological Change No one can dispute that AT&T has been responsible for im- pressive R&D advances over the years. As mentioned, the Communications 351 [...]... many Americans that educational reform was needed The growth of the cash economy and the withering away of the barter and trade system made many citizens demand that universal public education be firmly established so that everyone could take advantage of new opportunities More Americans entered the cash-based market economy, and many believed that the future of the nation’s children depended on an appreciation... and after the American Civil War (1 861 –1 865 ) and helped signal the start of a transition in education that would reach its peak during the first decades of the twentieth century The government authorized public land grants to the states for the creation and maintenance of agricultural and mechanical colleges Congress passed the Morrill Act, also called the Land-Grant College Act of 1 862 The primary objective... Congress promulgated the Rehabilitation Act of 1919, one of the first veterans’ benefits packages passed after World War I The act gave disabled veterans of the Great War monthly education assistance allowances as well as federal grants for rehabilitation through training The Vocational Rehabilitation Act of 1943 provided assistance to disabled veterans These rehabilitation programs remained high on the government’s... together a panel to evaluate the state of vocational education programs in the country The panel’s recommendations led to the passage of the Vocational Education Act later that year The act proved monumental for several reasons To begin with, it broadened the definition of vocational and technical education and no longer required the categorization of occupations in these areas; funding for all was covered... with the National Sea Grant College and Program Act of 1 966 It authorized the creation and operation of Sea Grant Colleges and programs by supporting education and research in the marine resources fields Educational programs for adults, including the training of teachers in adult education, expanded under the Adult Education Act of 1 966 The arts and humanities were enriched with the National Foundation... Foundation on the Arts and the Humanities Act of 1 965 This measure gave grants and loans for projects in the creative and performing arts It also gave assistance for research, training, and scholarly publications in the humanities The National Technical Institute for the Deaf Act of 1 965 called for the creation of a residential school for postsecondary and technical training of the deaf The following year, legislators... succession— the Marine Mammal Protection Act (1972), the Federal Water Protection Act (1972), the Endangered Species Act (1973), the Federal Land Policy and Management Act (19 76) , and the Alaska National Interest Lands Conservation Act (1980) With the adoption of the National Wilderness Preservation Act in 1 964 , before the furor raised by environmentalists five years later, the oil business and other extractive... The Adams Act required that grants to the agricultural experimental stations be taken from monetary surpluses in the Treasury, thereby severing the connection between grants and land (and land sales) With the passage of this act, the idea of direct federal payments to the states for vocational purposes became more acceptable Later, Congress created the Commission on National Aid to Vocational Education... the financial system, not remake it But progressive reformers such as Bryan and the lawyer Louis Brandeis were able to insist that the politically appointed board in Washington have ultimate responsibility over the system World War I further changed the American and, indeed, the world monetary systems The combatants abandoned the gold standard, and precious metal gravitated to the United States as the. .. industrial nations only gradually followed the American example They had suffered more inflation than the United States and had lost much of their gold reserves Britain, the most important of these nations, returned to the gold standard only in 1925 Even after that year, the dollar had a special place in the international system The United States had the world’s strongest economy, and it consistently ran a . fatal competi- tion, and the government established a strong national bank. In contrast, the typical small yeoman farmer initially saw few advantages and many disadvantages in a strong national. such as the South. The small hometown bank, once the norm across the American heartland, is be- coming a relic of the past. Similarly, Americans are facing new ways of banking with automatic. Louisiana’s agricultural commodities and chemicals, and will enable smaller manufacturers to break into foreign markets. Louisiana is a trade state. We have more ports and exports per capita than any