The Week Facebook Became a Regulated Monopoly (and Achieved Its Greatest Victory in the Process)

by on April 10, 2018 · 1 comment

With Facebook CEO Mark Zuckerberg in town this week for a political flogging, you might think that this is darkest hour for the social networking giant. Facebook stands at a regulatory crossroads, to be sure. But allow me to offer a cynical take, and one based on history: Facebook is potentially poised to score its greatest victory ever as it begins the transition to regulated monopoly status, solidifying its market power, and limiting threats from new rivals.

By slowly capitulating to critics (both here and abroad) who are thirsty for massive regulation of the data-driven economy, Facebook is setting itself up as a servant of the state. In the name of satisfying some amorphous political “public interest” standard and fulfilling a variety of corporate responsibility objectives, Facebook will gradually allow itself to be converted into a sort of digital public utility or electronic essential facility.

That sounds like trouble for the firm until you realize that Facebook is one of the few companies who will be able to sacrifice a pound of flesh like that and remain alive. As layers of new regulatory obligations are applied, barriers to new innovations will become formidable obstacles to the very competitors that the public so desperately needs right now to offer us better alternatives. Gradually, Facebook will recognize this and go along with the regulatory schemes. And then eventually they will become the biggest defender of all of it.

Welcome to Facebook’s broadcast industry moment. The firm is essentially in the same position the broadcast sector was about a century ago when it started cozying up to federal lawmakers. Over time, broadcasters would warmly embrace an expansive licensing regime that would allow all parties—regulatory advocates, academics, lawmakers, bureaucrats, and even the broadcasters themselves—to play out the fairy tale that broadcasters would be good “public stewards” of the “public airwaves” to serve the “public interest.”

Alas, the actual listening and viewing public got royally shafted in this deal. Broadcasters got billions of dollars’ worth of completely free beachfront spectrum along with protected geographic monopolies. Congressional lawmakers and the unelected bureaucrats at the FCC got power to tinker with broadcast content and received other special favors (like free airtime) from their cronies in the industry. People, money, and influence floated freely between the political and business realms until at some point there really wasn’t much distinction between them. Meanwhile, the public got stuck with bland fare and limited competition for their ears and eyes. The “public interest” ended up meaning many things during this time, but it rarely had much to do with what the public actually desired—namely, more and better options for a diverse citizenry.

Of course, much the same story played out in the U.S. telecommunications market a few decades prior to the broadcast industry making their deal with the devil. The early history of telecommunications in America was characterized by competition among a variety of local and regional rivals. But it was derailed by political shenanigans. Here are a few choice paragraphs about the cronyist origins of the Bell System monopoly from a law review article that Brent Skorup and I wrote back in 2013 [footnotes omitted]. As you read it, imagine how similar well-intentioned regulations might play out for Facebook:

… this intensely competitive, pro-consumer free-for-all would be derailed by AT&T’s brilliant strategy to use the government to accomplish what it could not in the free market: eliminate its rivals. In 1907, Theodore Newton Vail became AT&T’s president. He had a clear vision: achieving “universal service” (in the form of interconnected and fully integrated systems) by eliminating rivals and consolidating networks. Befriending lawmakers and regulators was a crucial component of this strategy. While many policymakers nominally supported the idea of competition, they were more preoccupied with achieving widespread, interconnected network coverage. Vail capitalized on that impulse.

On December 19, 1913, the government and AT&T reached the “Kingsbury Commitment.” Named after AT&T vice president Nathan C. Kingsbury, who helped negotiate the terms, the agreement outlined a plan whereby AT&T agreed not to acquire any other independent companies while also allowing other competitors to interconnect with the Bell System. The Kingsbury Commitment was thought to be pro-competitive, yet it was hardly an altruistic agreement on AT&T’s part. Regulators did not interpret the agreement so as to restrict AT&T from acquiring any new telephone systems, but only to require that an equal number be sold to an independent buyer for each system AT&T purchased. Hence, the Kingsbury Commitment contained a built-in incentive for network swapping (trading systems and solidifying territorial monopolies) rather than continued competition.  “The government solution, in short, was not the steamy, unsettling cohabitation that marks competition but rather a sort of competitive apartheid, characterized by segregation and quarantine,” observe telecom legal experts Michael Kellogg, John Thorne, and Peter Huber.  Thus, the move toward interconnection, while appearing to assist independent operators, actually allowed AT&T to gain greater control over the industry.

“Vail chose at this time to put AT&T squarely behind government regulation, as the quid pro quo for avoiding competition,” explains [Richard] Vietor.  “This was the only politically acceptable way for AT&T to monopolize telephony,” he notes.  AT&T’s 1917 annual report confirms this fact, stating, “[with a] combination of like activities under proper control and regulation, the service to the public would be better, more progressive, efficient, and economical than competitive systems.”

So much for “the public interest”! If the last century’s worth of communications and media regulation teaches us anything, it’s that good intentions only get you so far in this world. Many of the lawmakers and regulators who allowed themselves to be duped by big corporations asking for protection from competition probably thought they were doing the right thing. Those policymakers may even have believed that they were actually encouraging innovation and competition through some of their regulatory actions. Alas, things did not turn out that way. We the public were denied real, meaningful choices and innovations because of these misguided policies.

And so now it’s Facebook’s turn to become part of this sordid tale. Zuckerberg has already made it clear that he is open to regulation and that his firm would also start enforcing new European data rules globally. And after this week’s political circus in Congress, the floodgates will be wide open and everyone’s regulatory pet peeve will be up for political consideration, which is exactly what happened for broadcasters and communications in past decades.

Every crackpot idea under the sun will be on the table but the most extreme versions of those proposals will be beaten back just enough to ensure that Facebook can offer up its pound of sacrificial flesh each time without running the risk of killing the patient entirely. Again, this was always part of the broadcast and communications regulatory playbook as well. So long as they were guaranteed a fairly stable market return and protection from pesky new innovators, the firms were willing to go along with the deal.

The “deal” in this case between Facebook and regulators won’t be so explicitly cronyist as it was for broadcasters and communications companies, however. The days of price controls, rate-of-return regulation, and formal line of business restrictions are likely over. Everyone now recognizes that regulations creating formal barriers to innovation and entry are a bad idea and, as a result, they are usually rejected.

But laws and regulations can sometimes create informal or hidden barriers to innovation and entry, even when they are well-intentioned. And that’s what could happen here as this latest Facebook fiasco leads to calls for seeming innocuous things like transparency and disclosures requirements, restrictions on “bad speech,” advertising and data collection regulations, “fiduciary” responsibilities, “algorithmic accountability” efforts, and so on. Facebook hasn’t wanted to adopt some of these things in the past, but now they’ll be pushed aggressively to do so by policymakers and regulatory activists. As Zuckerberg and Facebook cozy up with policymakers and regulatory activists and begin talking about a “broader view of responsibility,” the transition to the firm’s next phase as a quasi-public utility will get underway.

The rich irony of all this is that the same regulatory advocates who are cheering on this week’s developments as well as the coming regulatory avalanche will be the ones howling the loudest if and when only Facebook is left standing in the social media universe. In fact, that’s already happened in Europe where policymakers and their burdensome top-down data protection regulations have driven most digital innovators and investors to other continents, leaving only Facebook, Google, and handful of other (mostly U.S.-based) companies left to regulate. And then European policymakers have the audacity to cry foul about the market power of these firms! It boggles the mind how European policymakers and regulatory advocates see zero connection between their heavy-handed approach to the Digital Economy and the corresponding lack of enough competitors in those sectors.

But none of that will make any difference to the regulatory advocates. They want that pound of flesh, and they are going to get it. And then in Facebook they will have a regulatory plaything to toy with for years to come.

What about the public? Will we really be any better off because of any of this? How many people will want to stick with Facebook if it becomes a digital public utility or a social media version of the Post Office? That sure doesn’t sound like much fun for us. But if the new regulations imposed on Facebook do end up hurting smaller rivals more and create barriers to new entry and innovation going forward, then it’s unclear whether it makes any difference what we want because the options just won’t be there for us.

With time, Facebook will not only become more comfortable with its new regulatory status for that reason but then in the name of ensuring a “level playing field,” the firm will simultaneously advocate that each and every new rule be applied to all its rivals. Again, this is how well-intentioned regulation ends up indirectly discouraging the very innovation and competitive options that we need. Broadcasters and communications companies played the “level playing field” card at every juncture to beat down new technologies and rivals.

Finally, at some point, don’t be surprised if all roads lead back to prices for digital services. Right now, social networking services like Facebook are free-of-charge to consumers and digital companies use advertising to support their services. Many regulatory advocates have suggested that this sort of business model is fundamentally incompatible with privacy and have wanted it strictly curtail if not ended altogether. Of course, if you ask the public how many of them would be willing to pay $19.95 a month for Facebook, you won’t get many takers.

I wrote a couple of law review articles talking about the “privacy paradox” and consumer “willingness to pay” for privacy more generally. All the evidence suggests that consumer willingness to pay for privacy is significantly lower than privacy advocates would prefer. But if in the name protecting privacy, prices get pushed or imposed as a matter of public policy, then we will have entered a truly surreal moment in the history of regulatory policy because we will have inverted the presumption that consumer welfare is better served by lower prices. Over the past century, the purpose of most public utility regulation was lower prices, higher quality, and more choice. The modern Digital Economy has largely achieved those goals without heavy-handed regulation. But now, with the emerging regulatory regime looming for Facebook and social media more generally, we might end up with a sort of bizarro policy world in which we make people pay more in the name of making them better off!

I hope I’m wrong about everything I’ve said here. It would be troubling if we enter an era of less competition, less innovation, and lower quality information services. But to borrow a quote from my favorite sci-fi show, “all of this has happened before, and all of this will happen again.” And regulatory history tends to repeat. We shouldn’t be surprised, therefore, when some forget the ugly history of public utility-style regulation or broadcast era “public interest” mandates and we find ourselves stuck right back in the hole that we’ve been trying to dig ourselves out of for so many decades.

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