The Fall of the Bell System, by Peter Temin & Louis Galambos

This book is in the dry and dusty style of economic histories, replete with footnote and references, yet I find it fascinating; I can hardly put it down. Perhaps this is because I was at the periphery of these events during my association with Tymnet. Tymnet was a component of the Fall. I had forgotten several phases of the Fall and I was ignorant of the details of many others. We worked closely with AT&T and I was impressed with the integrity of that institution. It seems to me now to be a rare case of central power remaining uncorrupted over an extended duration. The larger system was corrupt but in no mercenary sense; but I am getting ahead of my self.

On page 15 I note the irony of the Eisenhower administration supporting AT&T in the attempt by the Justice Department to split off Western Electric. This support was in the name of ‘preserving and strengthening corporate capitalism’, but amounted to preserving central planning, normally anathema to capitalism. While AT&T was not a centrally planned ‘government’ or ‘economy’, it did amount to central planning of a significant and growing portion of our economy. Note Romer’s remarks on the subsequent Microsoft trial.


This arcane issue is with us still today. It is difficult to understand and I will try to explain it in yet other words. It has to do with the price of long distance calls as decreed by regulators.

There is a notion that the price of a service provided by a regulated entity should be related to its cost. This notion is variously believed by regulators. The dilemma is that of allocating plant (hardware) costs to the ends it serves. This allocation problem is ancient and pervades all of accounting in competitive as well as regulated enterprises. It becomes a public issue in regulated industries. The local exchange can be viewed as providing two services:

Two perspectives seem reasonable, yet different:
  1. If we imagine a world with no long lines and no long distance service then the local exchange cost must be allocated entirely to local service. In such a world an unregulated entrepreneur L could subscribe to two exchanges and connect them with a long line that he builds. If the local exchanges are precluded from price discrimination against L and required by regulators to serve L on the same terms as its other customers, then some long distance service is possible with only a small proportion of the cost of the local exchange being allocated to the long distance service.
  2. On the other hand we might imagine another history where the local exchange was motivated largely by the anticipated benefits of, and revenues from long distance service; then one can argue for allocating the local exchange cost mainly to the long distance service. Even if the local exchange is largely occupied with local traffic, the greatest benefit is in the long distance service as measured by the costs of the alternatives to the phone calls. In this view, local service is a low value incidental by-product of the plant built for more important things.

It is clear that a regulator in the second frame of mind will decree higher prices for long distance calls so as to defray the cost of local exchanges built for this purpose. The book outlines the circumstances where this outcome was otherwise desired and which thus encouraged the second viewpoint. (During world war II the costs to AT&T-Long-Lines of providing long distance service were falling even as demand exceeded supply. Decreeing lower prices would increase the demand for an already scarce supply. I suppose that war time price controls and resultant artificial shortages precluded merely expanding the supply.)

The end result was that the local operating companies, with the FCC’s blessing, price discriminated against AT&T and charged them more for access to the local exchange. This extra charge was called “separations”. Read the book to find out how it got this name. AT&T thus increased its prices of all long distance calls and local companies could lower their prices for local service. These prices were set by the FCC not according to the costs of providing these calls, but in rough proportion to the geographical distance. They still don’t have the prices right.

This ‘cross subsidy’ has recently collapsed as local service is no longer a monopoly and there is competition in both local and long distance service. The after effects of a war-time market warping, lasted from 1945 until 2006. I wonder how much resource misallocation was caused. The world-wide collapse is still proceeding today.

I would love to know the thinking and rhetoric behind the decision to unleash MCI in the St. Louis — Chicago corridor. I strongly suspect that some of the FCC knew that they were planting the seeds of the downfall of AT&T and the set of distributed political arrangements that nourished it. I also suspect that there were many euphemisms in place to conceal such a thrust.

I relate this to the sort of hacking that is inspired as an attempt to show the contradictions in the plan for some larger system.

Temin never questions the economic wisdom of cross-subsidies, such as the separations, except to note that they were politically popular. Perhaps the economy would have been much better off if the users of long distance had not alone born the burden of universal access so long. Deregulation and polycentrism were the zeitgeist of the time and the uncoordinated forces against AT&T that the book chronicles reflect that ‘ideology’. I don’t know whether the alternative ideology of Vail had been forgotten by the broader set of players, or had never been known. I agree that ‘big is bad’ played an unfortunate rôle in the outcome, even though I applaud the outcome. The local operating companies were no less a monopoly to providing local service than they were before—I still had no choice in making local calls.


The book does not mention Internet, or its predecessor—ArpaNet. They had not yet become significant when the book was published. Evaluating the Fall of Bell must now consider this development. The Arpa net did not come out of Bell Labs. The Internet, evolved from Arpanet, was in part an economic experiment of the sort that Bell Labs did not do. There are many uses of Internet that would have been precluded in the regulator regime of the 50’s. I recall an opinion that one could not beam an information stream across a street because it would breach the telephone monopoly.

The Internet is peculiarly democratic. By this I mean that it is easy to set up a web site. The French Minitel service was a precursor of Internet which was set up by the French monopoly phone system. Becoming an ‘information provider’ on Minitel was considered a big deal requiring much sophistication. It was hard to become a ‘server’ on Minitel. I think that this was not any sort of corruption but merely a self fulfilling estimate. There were no blogs on Minitel.

Cable TV

One argument for a natural monopoly by the phone company was the inefficiency of stringing more than one set of wires. This was indeed tried at some places and times and indeed there were problems. Cable TV, however, snuck in and did this and now begins to offer local telephone service. This service is fully cross-connected with other phones and I don’t know what governmental force there is behind this. Cell phones have also broken the local phone monopoly for some.
This book relates clashes of the ideas and ideologies of many smart and honorable people. There are no villains. As Chaotic as it was, it looks like a good process.
A memorial to AT&T and the Bell System (Could Internet and web pages such as this have come about under the Bell regime?)
Interesting reflections on the history and demise of Bell
Western Electric lives on as a boutique supplier of electronic vacuum tubes.
FCC struggles to update and rationalize subsides
Recent Legislation: Universal Service Fund
2015 March FCC Internet order

The story of Electricity