Information monopolists as cyclic products of network effects: Tim Wu

Tim Wu’s excellent new book, The Master Switch: The Rise and Fall of Information Empires, chronicles a history of communications policy and the long-term behaviour of firms in information industries. His basic thesis is that such firms acquire market power by a combination of network effects and industry consolidation, then exert a form of regulatory capture that allows them to alter the rules of the game so as to drive out competitors and extract rents from their monopoly infrastructure.

A recent piece published in The Wall Street Journal provides a neat summary of these ideas and serves as a kind of postscript to the book itself:

Today’s Internet borders will probably change eventually, especially as new markets appear. But it’s hard to avoid the conclusion that we are living in an age of large information monopolies. Could it be that the free market on the Internet actually tends toward monopolies? Could it even be that demand, of all things, is actually winnowing the online free market — that Americans, so diverse and individualistic, actually love these monopolies?

The article goes on to examine how information monopolies develop. Wu’s basic method is historical, examining how similar patterns emerged in the telegraphy and telephony industries during the late 19th century:

Internet industries develop pretty much like any other industry that depends on a network: A single firm can dominate the market if the product becomes more valuable to each user as the number of users rises. Such networks have a natural tendency to grow, and that growth leads to dominance. That was the key to Western Union’s telegraph monopoly in the 19th century and to the telephone monopoly of its successor, AT&T. The Bell lines simply reached more people than anyone else’s, so ever more customers came to depend on them in a feedback loop of expanding market share. The more customers they reached, the more impervious the firm became to challengers.

Just what happens to these information monopolies? Wu says that they follow a pattern of ascent and decline, beginning with market and regulatory dominance and ending in widespread consumer harm. Interestingly, though perhaps unintentionally, he invokes the Nietzschean metaphor of the ‘will to power’:

Info-monopolies tend to be good-to-great in the short term and bad-to-terrible in the long term. For a time, firms deliver great conveniences, powerful efficiencies and dazzling innovations. That’s why a young monopoly is often linked to a medium’s golden age. Today, a single search engine has made virtually everyone’s life simpler and easier, just as a single phone network did 100 years ago. Monopolies also generate enormous profits that can be reinvested into expansion, research and even public projects: AT&T wired America and invented the transistor; Google is scanning the world’s libraries.

The downside shows up later, as the monopolist ages and the will to innovate is replaced by mere will to power. In the 1930s, AT&T took the strangely Luddite measure of suppressing its own invention of magnetic recording, for fear it would deter use of the telephone. The costs of the monopoly are mostly borne by entrepreneurs and innovators. Over the long run, the consequences afflict the public in more subtle ways, as what were once highly dynamic parts of the economy begin to stagnate.

It’s unclear whether all internet industries have quite reached (or will ever reach) the descent into rent-seeking just yet. For one thing, switching costs (the cost it takes to move from one firm’s service to another’s) are almost non-existent (particularly if data portability is present), and it’s also doubtful whether even Google has managed to lure regulators to reinforce its dominance or threaten competition (just look at copyright exceptions, net neutrality, three strikes and a host of other anti-intermediary forms of regulation). However, Wu’s argument about the historic behaviour of intermediary monopolists is compelling and warrants further consideration. Certainly, he’s correct to assert that, despite the many competitive pressures facing info-monopolists, most incursions into their markets have failed to change their dynamics. Is the internet is somehow different or will it fall into the same patterns of monopolistic decline as previous info-networks? If this is inevitable, can it be prevented (or its harmful effects diminished) through regulation?

Update: more discussion, though of a somewhat definitional nature, at Tech Liberation here, including a helpful response by Professor Wu.