As A Society We're Better Off For Detroit's Collapse

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Owing largely to quirks in the inherent physics of electrified communication, largely related to power issues and signal decay, there developed a two-stage system of telephony inside the United States. When Alexander Graham Bell patented his version of the telephone, it only solved the problem of being able to turn symphonic pulses into electrical impulses that could travel over wire - the distance they could travel was entirely another matter.

So it developed through the last quarter of the nineteenth century this idea of local telephone service as separate and distinct from "long distance" (a concept our children already find bewildering it ever existed). For the most part, the technology of local systems was set in place, and companies, predominately the Bell system as it became AT&T, focused technological advancements on extending signals into longer and longer distances.

There was in local service a hodgepodge of different carriers after the original Bell telephone patent expired. By 1913, AT&T was competing for local service with independent carriers in 1,234 communities; with other competition in 630 additional communities. The problem from the standpoint of a customer in these competed cities and towns was the inability for integration.

In Buffalo, NY, for example, in 1910 there were an estimated 25,000 telephone lines in existence, a rather robust amount. There were competing exchanges for those lines, typically cleaved into affiliations with either the Bell system or Edison. Those served by Bell would be unable to communicate with those served by Edison affiliates, meaning choice of telephony could split friends and family.

This unsuitable arrangement led to consolidation of lines into the Bell monopoly. In 1921, Congress passed the Willis Graham Act that established the principle of "natural monopoly" applied to telephone service. Oversight of this monopoly was to be under the Interstate Commerce Commission. Between 1921 and 1934, the ICC approved 271 of AT&T's 274 requests for consolidation.

AT&T was able to dominate as the monopoly because of its prime position in long distance, ably applying innovation to its services. In 1913, when threatened by the remnants of the Sherman Antitrust push leftover from the Teddy Roosevelt administration, the company, under the Kingsbury Commitment, agreed to open its long distance service to other independent carriers. While it also gave up its ownership in Western Union, after winning a battle that went back decades to the struggle with the telegraph and Edison, it did not, nor was it ever forced to, agree to interconnect its local services with other local providers (like in Buffalo). The company was also able to exclude competing long distance providers from its own advanced long distance network.

Eventually, because of this arrangement and logistical framework, AT&T was all that was left. In 1934, it was set as a fully regulated monopoly under the Federal Communications Commission.

Because of the advances in distance-driven communication, by the 1960's long distance service was much cheaper to provide than local service. The FCC allowed long distance rates to remain well above cost as a means to continue the perceived stability in local service. As long as AT&T agreed to subsidize local telephone costs through this pricing dichotomy, it would be able to charge premium prices in the long distance space.

Owing, however, to antitrust action in 1949, AT&T was increasingly limited in its applications of its own technology advances. It pioneered several innovations that would become a core part of the coming computer revolution, but by FCC Consent Decree in 1956 (relating to that 1949 action) the company had to stay out of computers altogether except through licensing its own technology to others. This led to other large companies developing their own long distance communication and computer networks independent of the monopoly system; first through microwave relays and then satellites after Telstar I launched in 1962.

In October 1963, Microwave Communications, Inc., was incorporated to build and operate a microwave relay system between Chicago and St. Louis. Following an FCC ruling in June 1968 that held AT&T's prohibition of two-way communication traffic connecting to its telephone network illegal, MCI was poised to exploit the monopoly pricing anomaly for voice and computer traffic. It could provide microwave long distance at the monopoly long distance rates without the need and massive cost to subsidize local service.

AT&T objected in numerous ways and means, leading in 1973 to a government lawsuit against AT&T that alleged improper denial of connection to MCI and others. By March 1974, MCI had filed an antitrust suit against AT&T, at the time the largest corporation on the face of the planet. By 1976, a Federal judge ruled that AT&T's status as an FCC-regulated "common carrier" did not give the company immunity from antitrust suits and actions, thus putting AT&T into a completely defensive posture.

By then, the company finally awoke from being solely concerned about protecting its monopoly and re-oriented to focus on the profit potential from its own innovations as it saw them being applied by so many others. Because that monopoly had prevented exploitation of computer technology, the company only belatedly saw that its future lay outside of the monopoly it carefully crafted in the Kingsbury Commitment more than six decades prior. Innovation, including its own, had forced its hand and the company no longer saw its future prosperity tied to maintaining itself as it had existed for decades, so in January 1982 the company agreed to its historic breakup.

The theory was that separating the monopoly (local service) from the competitive enterprises (Bell Labs and long distance provisions) would both satisfy the government and MCI, therefore unlocking so much hidden potential inside the business' asset portfolio and Bell Labs' (which would become Lucent) history of innovation. As it negotiated the breakup with the government, this theory became reality when the FCC agreed to finally lift the 1956 Consent Decree, finally allowing AT&T to branch into the computer business.

By then, AT&T was already well behind the curve. Computer and related businesses had already entrenched, many based on the advancements made at Bell Labs. Not only did 3 scientists from Bell invent the first transistor in 1947 (John Bardeen, Walter Brattain and William Shockley were awarded the 1956 Nobel Prize in Physics for their work at Bell), the first carbon laser was developed by Kumar Patel in 1964, with its theoretical foundation (and even the term LASER) coming from a 1958 scientific paper authored by Bell Labs researchers. The company also developed UNIX and C programming language trees, as well as the first digitally multiplexed transmission of voice signals - laying the foundation for the internet and modern digital convergence of telephony and computers.

William Shockley, as it turned out, left Bell Labs in 1955, starting his own business, Shockley Semiconductor, to pursue avenues in computer technology that would never have been exploited under the AT&T/Bell Labs umbrella. By then, silicon had been produced with acceptable impurity levels and the first diffused-base silicon transistor had been fabricated. Shockley planned to lure Bell Labs' best and brightest to work on diffused-silicon devices, but many were too rooted in New Jersey to follow him.

He did succeed in bringing several notable scientists and engineers, including a man by the name of Robert Noyce, who had attended the third Bell Labs symposium on transistor technology in January 1956 devoted to advanced silicon technologies. The new Shockley Semiconductor was to be a division of Beckman Industries; Arnold Beckman being a fellow Caltech alumnus with William Shockley. Beckman had already acquired rights to the Bell Labs transistor patents which were now completely off-limits to Bell and AT&T due to that 1956 Consent Decree.

Not long after Shockley received the Nobel Prize, he was the recipient of a package from the patent licensing engineer at Western Electric - AT&T's manufacturer, or where Bell Labs' innovations became products where allowed. Without getting too far into the technology, it essentially gave Shockley and his team vast insight into what would become a core enabling technology for silicon integrated circuits.

It would not be Shockley Semiconductor that would ultimately exploit these advancements, however, as most of his senior team, including Robert Noyce, left for a company founded by Noyce, Fairchild Semiconductor. This company would go on to patent the silicon chip, based in large part to the work of Bell Labs and Shockley. But Noyce wasn't done as he began searching for a team to staff another startup aside Fairchild. Among those he contacted was Marcian Edward Hoff, a PhD in electrical engineering.

Hoff would join Noyce as his twelfth employee, having only met him on one previous occasion. Between 1969 and 1971, Hoff put together what would become the first microprocessor, and this startup, Intel Corporation, would thus revolutionize the face of computing and technology for the entire planet.

The collaboration among all these various scientists and engineers inside and out of Bell Labs largely took place in Santa Clara, CA. The allure of 1950's California had already pushed the population of Santa Clara County from 174,000 in 1940 to 642,000 by 1960. The growth of the "technology" industry pushed it to 1.3 million by 1980, and 1.5 million by 1990, thus outpacing the overall population growth for the state of California as a whole. Despite the slowdown of technology and "Silicon Valley" in the intervening years, the population is still growing, now an estimated 1.8 million (2012 Census estimate).

At the same time as Santa Clara was gaining such population expansion, Detroit was hooked on aging technology and businesses. While the Big 3 carmakers of GM, Ford and Chrysler acted as a cartel in a manner not unlike AT&T's monopoly, there was little innovation coming from them. In fact, most innovation in automobile technology was to be developed and offered by foreign manufacturers that would eventually trigger the proximate downfall of the domestic car industry.

In this respect, AT&T and the Big 3 were not all that dissimilar, captured by the priority of protecting their own businesses before profiting on the messy and dynamic innovations they spawned (or might have if they cared to). While Shockley, Noyce and Hoff were busy creating entire new industries from scratch, the Big Three and AT&T were lulled into the security of largely complacent industries, both to varying degrees aided by government rent-seeking (officially in AT&T's case). Unionization contributed mightily to the rigidity that crept into all their business models as they were falsely comforted by their own industry positions, but the lack of innovation, or exploitation of them, was where it really went awry.

At that time it was easy for the carmakers, in particular, to extrapolate in a straight line into the future, expecting similar levels of success and extravagance (for both unions and management) far out in time, but that kind of stability is simply false and wishful thinking. Ours is a dynamic world that actually thrives on change, something that AT&T was forced, kicking and screaming, to deal with in the 1970's. While it was too far behind to become a titan of the computer and internet revolution, where it rightfully belonged given its contributions to the efforts, it at least recognized its own survival was at stake before it was too late. The Chrysler debacle of the 1970's should have had a similar impact, but did not.

For every Detroit that falls prey to such fatal conceit, there should be a Santa Clara that takes its place atop the renewal- and we, society, are all the better for it. This is the engine of true capitalism in all its glory, and its heartache. Creative destruction can be extremely messy, but it is, without reservation, absolutely and totally necessary.

Detroit fell not because of one thing or another, but because in those combinations of negative factors it built an exclusive foundation on the idea of permanence, and thus entitlement to that idea of permanent prosperity. No such thing exists in either the natural world or the real world of business and industry, but it was simply expected in Michigan.

In that way, Detroit was a victim of its own success, as is America to a certain degree. We have taken the notion of permanent prosperity and incorporated it into every degree of financialization and economic management. We seek to sow this element of permanence as if it were a substitute for true prosperity - economic salvation lies not in propping up Detroit and GM, but in ensuring both can be replaced by the next great wave of innovation. The only way to do that is to get out of the way and allow markets to once again prove the conditions for fertile expansion are free of economic "management" and intervention. This idea of permanent prosperity, be it in fiscal measures to "bail out" mature companies or to help them protect their turf from the next innovator nipping at their heels, or in monetary hubris that seeks to control economic means through "market" interventions, is that dangerous illusion that introduces such fatal sclerosis.

Chairman Bernanke cannot create the next Intel or unlock the hidden genius and value in the next Bell Labs, but he and his FOMC compatriots may very well be contributing to their conspicuous absence. By keeping mature firms alive with intervention, alongside rent-seeking from the growing creep of government rulemaking, the next wave of innovation may have been overridden by the attempt at maintaining such false stability. The firms of today, full up balance sheets of leverage, can swallow any new innovator before they have an impact. The Noyce and Hoff of 2013 may well get gobbled up in the frenzy of froth-driven M&A long before they can spawn the new industries needed to rebuild Detroit in another location free from so many past obligations.

Would the pioneering efforts of Bell Labs be exploitable in today's monetary and fiscal climate? Such counterfactuals are wholly unanswerable, so this simple rhetoric is left to the imagination. The distinct magic of Silicon Valley will never be recreated, but, as they say, history doesn't repeat, it rhymes. And you have to wonder where the next Silicon Valley has been. It is now more than five decades since the foundation for the internet revolution was laid and there does not seem to be another wave of innovation and industry anywhere on the horizon (fracking doesn't count since it is advancement within an existing industry, and it has been employed since the 1940's).

In the meantime, we have seen an explosion of debt and "money" in tremendous innovative leaps of finance, all seeking one single purpose - to maintain the idea of permanent prosperity where it doesn't belong. Innovation is not supposed to be trained inward, it is supposed to leap outward in expanding economic frontiers to places never imagined; new industries yet to be born in places, and doing things, we cannot yet conceive.

True economic stability, in the form of robust long-term economic growth, means embracing dynamism and all its messy transitions. If we refuse to countenance change and outward innovation we become Detroit, reduced to fighting for scraps of former glory. Free markets need to function without so much interference, and that is what Detroit's sad and slow descent from intransigence should convey. AT&T, to the contrary, was forced to wake up and face that fact due solely to market forces beyond its own control, and in doing so actually survived in a business it never really foresaw as being so pivotal. In fact, the company has thrived despite the old landline monopoly business' descent into historical oblivion. There is a lesson in there somewhere, for carmakers, the next Detroit and even those that wish to control the economy in the vain pursuit of a permanence that is fully unnatural and, in the end, economically fatal.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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