Trends

The Bell's Tolling For Local Phone Monopolies

Another nail has been driven into the coffin of local phone monopolies. In May, American Telephone and Telegraph (AT&T) for the first time said it would "bypass" one of its former local phone companies: later this year it will directly connect long-distance service to Merrill Lynch's new Manhattan headquarters without going through the local phone company, New York Telephone (NYT), an AT&T unit until the 1984 AT&T divestiture that spun off all of the company's local phone operations.

Projected cost savings is the primary reason for the bypass arrangement. Because the setup won't use NYT lines, AT&T won't have to pay the huge "access fees" that local phone companies charge to connect long-distance service to a customer's phone lines.

But Merrill Lynch is far from alone. This summer, for example, Dow Jones & Co. is installing a telecommunications line directly between its Princeton, New Jersey, and Manhattan offices, bypassing the local phone monopolies at both ends. The New York Times reported recently that in a survey of 400 of New York Telephone's largest customers, "17 percent said they plan to have bypass systems by year-end." And the New York research agency the Conference Board reported that of 348 companies it surveyed, some 80 percent already have or plan to install a bypass system.

Many of these firms—as in the Merrill Lynch and Dow Jones setups—will use the services of a "teleport," a kind of telecommunications hub. In the Merrill Lynch arrangement, for instance, the Staten Island–based Teleport Communications will shuttle phone signals via fiber-optic cable between Merrill Lynch's offices and AT&T's long-distance lines.

This type of direct competition for local service—especially for that of heavy phone users—poses a major threat to the local phone monopolies. And it's not going to go away. "More than 25 teleports are now in operation, under construction or in the planning stage across the United States and Canada," Nation's Business magazine recently reported. And last year, teleport operators formed a trade group, the American Teleport Association.

One major activity of teleports is to send, receive, and distribute communications via satellite. This fast-developing technology, in fact, is a significant factor in the bypass trend. Major companies with many retail outlets or outlying operations are setting up their own private satellite networks, both to improve their communications and to cut its costs. For instance, both Wal-Mart Corporation and Southland Corporation (owner of the Seven-Eleven convenience-store chain) plan to install multimillion-dollar satellite systems. Federal Express is setting up a satellite network to interconnect thousands of its corporate ZapMail customers. And Farmers Insurance Group has already started to connect its 3,000 sales agents and 170 claims offices via satellite to its Los Angeles headquarters, expecting to cut its phone bill by $1 million annually.

The bypass trend has put local phone monopolies between the rock of increasing competition and the hard place of a regulatory system out of sync with the new communications age. Something's got to give, and signs are that it will be that venerable institution that everybody loves to hate, the local phone monopoly.

Military Experts Volunteer Objections To the Draft

Twelve years after the institution of an all-volunteer military, there are continuing calls for reinstating the draft system that had reigned until 1973. But some military officials are making life difficult for draft supporters by going on record with their assessment that a draft is not necessary.

"I really don't see a need for a draft in the near term," Gen. John Wickham, the Army's chief of staff, recently told the New York Times. And Lawrence Korb, the Pentagon's senior personnel official, has been opposed to the draft for some time.

Wickham and Korb don't speak for the record about the moral inelegance of slave labor. But they're convinced of its high price and inefficiency. Training costs are far higher in a military of draftees than in an all-volunteer military, because draftees are quite likely to leave the military as soon as they can. Korb told the Times that in the past, about half of all volunteers have reenlisted, while only about a tenth of draftees stay in the military. Because of that high turnover, Wickham believes that a return to the draft would require enlarging the Army alone from 781,000 to 850,000 to compensate for all the new soldiers who would be in training at any given time.

It's significant that Korb and Wickham are publicly supporting the all-volunteer military at a time when the draft's supporters are warning of dire days ahead. Draft supporters cite a recent survey indicating that the number of young people who say they might enlist in the military declined from a range of 33–36 percent in the 1980–83 period to under 30 percent in 1984. Moreover, the supporters of the draft also point to Census Bureau reports that the number of draft-age men in the population started declining in 1979 and will continue to go down until 1992.

But Korb, for one, has concluded that these aren't sufficient reasons to bring the draft back. Not only are retention rates currently high, but the military is attracting a comfortably large percentage of high-school graduates (92 percent) among its recruits. "We've managed pretty well," he told the Times, "and I think we can manage until 1992."

Not content with such expert counsel, conservative Sen. Ernest Hollings (D–S.C.) has introduced legislation that would reinstate the draft. Meanwhile, Gen. Bernard Rogers, who commands US forces in Europe, has called for an end to the all-volunteer force. (Ironically, Rogers commands 300,000 US troops that were never meant to be permanently stationed in Europe—see "Standing Guard over Europe," REASON, Aug. 1984.)

It's too early to know how much mischief Hollings, Rogers, and their ilk will make. But the facts are there: the all-volunteer military is working well, and those in the know believe it will continue to work well in the future. The system that does not infringe individual liberty is also quite practical.

Clear Thinking Overtaking Takeover Controversy

Whether it's Ted Turner eyeing CBS or oilman T. Boone Pickens licking his chops over Unocal, a day doesn't go by, it seems, that someone isn't trying to take control of some big, established corporation whose managers don't want it to be acquired. "Hostile takeovers," they're called, and a lot of people are getting quite exercised about the supposed evils of it all.

They worry that all the money behind both the takeover bids and the target companies' efforts to stave off acquisition is being diverted from more-productive uses. They worry, too, that company managers, in jitters about the takeover specter, will concentrate on short-term earnings—to the detriment of investment in research and development—in order to dissuade takeover bids: strong short-term earnings, so the alarmists' theory goes, serve to boost the company's stock's value; this will keep the company from being perceived as "undervalued," a prerequisite for most takeover efforts. They also worry that an increasingly common method of financing hostile-takeover efforts—"junk bonds" (corporate bonds that pay a relatively high rate of interest because of the low credit rating of the company issuing the bond) threaten to wreak havoc and widespread loss throughout the financial markets.

The anti-takeover rhetoric is flying high and swift, and a number of federal legislators have introduced bills that would slap heavy restrictions on corporate takeovers. Yet behind all the talk there is little substance. Analysts have lately produced a number of cogent arguments and powerful data that strongly contradict the alarmist hype.

Concern that takeovers somehow divert scarce funds away from productive investments, for instance, is simply convoluted thinking. Fortune magazine writer Aloysius Ehrbar, in a recent article on the takeover issue, helped untwist that notion. The money that "acquirers pay for companies goes to shareholders, few of whom, it seems safe to assume, tuck it under their mattresses. The only money that moves out of the savings pool is what individual shareholders spend on consumption, and even that stimulates the economy and ultimately leads to investment."

What about the claim that takeover-spooked managers will focus on short-term earnings and neglect R&D? In the Wall Street Journal in May, economists Gregg Jarrell and Kenneth Lehn of the Securities and Exchange Commission reported that, according to their study of 1980–83 information about more than 300 companies, investors actually showed "a noticeable preference for firms with increasing R&D expenditures." Moreover, in the 1980s, firms targeted for takeovers "are characterized by very low R&D expenditures."

Fortune's Ehrbar summed up the drift of such evidence: "Managers who crimp on capital spending and R&D in order to boost short-run earnings are likely to push their stock price down, not up." This, of course, would make a company more vulnerable to a takeover. Indeed, wrote Ehrbar, "there is little convincing evidence that fear of takeovers has in fact caused large numbers of companies to slight future growth for the sake of short-run profits."

As for the worry that "junk-bond" financing of takeover bids will cause major financial problems, again the data don't support the concern. On the contrary, Fortune writer John J. Curran recently reported, "mutual funds that played a junk-bond hand far outperformed those that bought U.S. government bonds or A-rated corporate bonds over the past five and ten years." Over the past 10 years, junk-bond funds yielded a 214.5 percent return on investment, while corporate-bond funds returned 147.6 percent, and US government-bond funds, 143 percent.

Against the alarmist portrayal of hostile takeovers as a sordid drama in which wicked predators use scam-like methods to acquire established firms, break them up, and sell the pieces for a quick profit, there is a more-sophisticated and studied view of the process. From this other perspective, extensively elaborated by economist Henry G. Manne of the Law and Economics Center at Emory University, hostile takeovers occur because some individual or individuals believe that a corporation is underperforming—not earning its shareholders the best return on their investment, that is—and therefore try to gain control of the firm. Such competition for corporate control, Manne and others argue, in fact keeps managers in general on their toes, spurring them to increase their company's efficiency—and those who fail will be ousted by others who think they can do a better job.

If, however, the government prohibits or impedes the functioning of this mechanism, many more companies would go the way of those that, by their very inability to perform up to par, have become today's takeover targets. Fortunately, more and more people appear to be appreciating that point. Now if only policymakers would hear the message.

Doubts about Social Security Come of Age

The Social Security system has always had its opponents in principle—people who object to such involuntary, redistributionist programs. And Social Security from time to time has had reform-minded critics, whose voices wax and wane with the system's financial health. But with a growing portion of the population—now 28 percent, according to Census Bureau data—getting some income from the system, the political chances of change have been dim.

Enter a new group, Americans for Generational Equity, with the potential of tapping a large constituency for rethinking Social Security. The data behind the group's name are increasingly discussed.

A premise of popular support for Social Security has been that it helps mostly elderly people who need help, drawing from the pockets of younger, working people who can afford the tax burden. But both sides of the equation are off.

Recipients aren't all nearly as poor as many people believe. The elderly are the vast majority of Social Security's recipients, and according to Census Bureau data, the percentage living below the poverty level dropped from 24 percent in 1970 to 14 percent in 1983. And Paul Hewitt, an aide to Sen. David Durenburger (R–Minn.) and the president of Americans for Generational Equity, reports that about 25 percent of all Social Security payments go to families with annual incomes over $30,000.

On the other side of the equation is the fact that the baby-boom generation, now bearing the brunt of the growing tax burden of Social Security, isn't nearly so well off as the imagery implies. In a Wall Street Journal editorial-page essay, Phillip Longman recently compared the economic lot of baby-boomers with that of their parents. He noted that for families headed by a person 25 to 34 years old, real after-tax income declined 2.3 percent from 1961 to 1982. This is despite the fact that married couples in that age group are much more likely now to have two paychecks rather than one coming in, since labor-force participation by married women 25 to 34 has grown from 29 percent in 1961 to 62 percent.

There are other measures of decline for this age group. Longman noted that "in relative terms, starting wages for both sexes have never been lower." And their purchasing power is down. A young family in the 1950s with a median income—often with just one wage earner—could comfortably purchase their own home. But by 1983 it took two incomes for more than 65 percent of first-time home buyers.

Faced with such figures, some people are starting to fight fire with fire—or, more literally, to fight over-65 lobbies like the powerful American Association of Retired Persons with a new baby-boom membership organization, Americans for Generational Equity (AGE). The group plans to develop positions and conduct original research on the budget deficit, entitlements for the elderly, and other issues where the interests of young people are often neglected unfairly.

To a large extent, the politics of AGE don't surmount the statism that underlies Social Security. For instance, the group obliquely condemns the government for not spending more on dams, bridges, and roads. Yet its formation reflects a growing dissatisfaction with New Deal solutions, and mobilizing the people who are penalized by the system may be an effective first step on the road toward retirement support more consistent with a free society.

Private Business Takes the Driver's Seat In Mass Transit

Private businesses now operate 3–5 percent of all mass transit, up from just 1 percent in 1981. There are some 100 private mass-transit bus companies nationwide. Four hundred firms operate van services.

In Dallas, the New York Times recently reported, the rapid-transit agency contracted out operation of an 80-bus express service to Trailways bus line last year. In Glendale, California, the local government has hired a private company to operate a shoppers' shuttle, and the Lexington, Kentucky, transit agency has contracted with private operators for rural and weekend service. Dade County, Florida's transit agency has set up private routes in Homestead and Florida City. And, the Times reported, the Los Angeles County Transportation Commission has announced that it will hire private operators for a shuttle service and for a new park-and-ride route.

Private-sector involvement in transit is even extending beyond operation of routes. "Private investors are becoming involved in financing the development of systems," the Times reported. "In Washington, D.C., private investors have proposed a rapid rail system to Dulles Airport."

Much of the shift to privatization comes from a deliberate push by the Reagan administration to encourage greater private-sector provision of transit. The administration is cutting back federal subsidies to transit systems—from $1.1 billion in 1980 to $870 million in 1985—with the goal of eventually ending all federal operating subsidies and cutting capital subsidies in half.

In addition, a recently enacted policy of the Urban Mass Transportation Administration (UMTA), the office that controls federal transit aid, requires governments and agencies that receive federal funds to allow private firms to bid on contracts to serve any new or reorganized transit routes or facilities.

Ralph Stanley, head of UMTA, recently commented, "We see privatization as the wave of the future. We think the time has come for demonopolization and flexibility." The reason is clear: private transit operation is more efficient than government-run systems. Data from the growing private transit industry support the claim. For instance, one private Westchester County, New York, bus line operates at a cost of $3.18 per mile, while a government line in New York's Nassau County costs $4.09 a mile to operate. Even more telling is the fact that, nationally, government transit systems cover only 40 percent of their costs through fares.

Despite the testimony of both evidence and economic logic, many public transit officials still spout skepticism about private companies' ability or interest in operating urban transit systems. Perhaps they should take a look at Argentina's colectivos.

In operation since 1928, colectivos are private, unsubsidized buses, able to seat 21 passengers, that offer a common, colorful sight on Argentina's streets. In Buenos Aires, for example, 11,000 of the brightly decorated colectivos—in addition to 30,000 taxis, most owned by their drivers—offer "cheap and efficient transportation," as a Los Angeles Times correspondent recently reported. "City governments used to run their own red-ink bus lines in Argentina," Times reporter William D. Montalbano wrote, "but they have all surrendered to the colectivo."

More than 300 companies, most of them professionally managed corporations, run colectivos in Buenos Aires. In 1984, Montalbano reported, the buses "carried 2.5 billion passengers and provided 52% of all urban transportation." The companies make money year in and year out, no matter what the economy is doing—in Argentina's economically bad year 1983–84, one company, for instance, paid its shareholders a 5.7 percent dividend on gross revenues.

Why are the colectivos so successful? One industry spokesman offered an explanation: "We are good managers. That is the only secret. People who run the lines are close to their operations. They are agile, and they are decisive."

Our bet is that American entrepreneurs, given a similar opportunity, could say the same thing.

The Rights Way to Own The Airwaves

It's commonly assumed as part of the US government's regulatory claim over the broadcast media that the airwaves are "public property"—that they are owned by "the people" and the government serves as steward. This widespread notion, it appears, is a misconception.

Attorney Erwin Krasnow, an expert in communications law, recently wrote in a Washington Times op-ed article that "the concept of public 'ownership' of the airwaves is demonstrably at odds with Congress's intent in enacting the Radio Act of 1927 and the Communications Act of 1934." In fact, Krasnow reported, "When enacting the Radio Act of 1927, the Congress specifically deleted a House-passed declaration of ownership." And Krasnow quotes a statement by one of the act's coauthors, Sen. Clarence Dill: "The government does not own the frequencies…or the use of the frequencies."

Nonetheless, the government undeniably claims the power to regulate the airwaves, including the authority to allocate frequencies among users. Historically, the government has allotted frequencies either on a first-come, first-served basis or through a lottery. Both methods, however, risk inefficient use of the airwaves. Recognizing this, free-market economists have long suggested a market-based system of allocation, whereby rights to specific frequencies can easily move from less- to more-efficient users. The way to do this, they say, is to make rights to frequency use private property that can be freely bought and sold in the marketplace.

There are signs that this idea may be catching on. The British government, for example, recently commissioned a study of the various benefits of bringing market forces and the price mechanism to the allocation of radio frequencies. And in the United States, Mark Fowler, chairman of the Federal Communications Commission, has proposed auctioning frequencies for cellular radio and other communications services (though not for radio and TV licenses).

In recent congressional testimony, Fowler noted the lamentable results of trying to select cellular-radio operators by lotteries. The process has turned into something of a "sweepstakes," he said, in which entrants submit multiple applications—perhaps under names of various family members and friends—thus trying to increase their chances of winning. Fowler suggested to the congressional committee that auctioning the cellular rights to the highest bidders not only would streamline the selection process but would get those rights into the hands of the most-efficient users.

Fowler's on the right track. What he ought next to consider is allowing such rights to be bought and sold, thus assuring that they will be put to the most efficient use over time.

Global Trends

Denationalization South of the Border

MEXICO CITY, MEXICO—Mexico continues down a denationalization road. The trend began last fall, when over 100 state-owned firms were sold back to the private sector. In February the federal government took another big step when it announced the sale of 202 more firms and the closing of 32 others. This measure comes in the midst of Mexico's most severe economic recession in 60 years. Its proponents hope to mitigate growing dissatisfaction with many of the socialist-leaning policies that characterized the past two administrations, of Luis Echeverría and Josè Lopez Portillo, whose shadow still haunts President Miguel de la Madrid.

The sale is part of an emergency spending-reduction package—a response to increasing gaps between the government's professed goals for the economy and its actual performance. Unemployment and taxation rates are at all-time highs, inflation is far from being controlled (it now stands at an annual rate of 70 percent, made worse by a 25 percent ongoing currency devaluation), and the Mexican political atmosphere is heating up. Scattered rioting has already occurred in the northern areas, which are traditionally volatile. The government hopes that the sale of more of its so-called "parastate enterprises"—all of which operate at a loss—will appease some of the more free-enterprise factions while at the same time alleviating budgetary constraints.

The firms in question are in various areas of the economy. Hotels, sugar refineries, tile and soft-drink manufacturers, real-estate promoters, textile factories, tobacco wholesalers, bookstores, and household-appliance companies are all included on the list. Even though they are by no means among the largest state-owned ventures in Mexico, their transfer to the private sector is seen by many as an indication of future sales of many others.

At the least, the transfer is a signal from the present administration that from now on, the government's role in the economy will be limited to certain primary areas. Carlos Salinas, the secretary of Budget and Programming, has said that "the government has no intention of abandoning its exclusive role in such strategic areas as telecommunications, the oil and energy sectors, banking, transportation, and [prime] industrial materials." But denationalization of "nonstrategic companies" that operate at a loss, he said, "does not interfere with our function of developing the country. We would rather build roads, schools, hospitals, steel companies."

There is a way that denationalization could go wrong, however: no one may actually purchase the firms in question. They are not financially sound ventures, and they're being offered for sale at a time when most prospective investors in Mexico are out of cash, lack confidence, or have already committed their resources elsewhere—most notably, in the sale of state-run firms in 1984.

Possible renationalization is also a concern. Jorge Kahwagi, vice-president of the National Chamber of Industry, says "the sale of these firms is a historic measure; but it will be to no avail unless the government clearly defines, once and for all, which areas are meant for it and which for private enterprise, so that we may proceed without fear of unfair competition or nationalizations."

So some analysts see the government sale as a big gamble. "The lack of confidence and inflation are the principal problems of the Mexican economy," writes Mexican economist and author Luis Pazos, "and both have their origin in the excessive share and control of the public sector of the economy. Thus, the way in which the announced spending cuts and sale of firms are carried out may bring either a genuine rebirth of confidence or its complete demise."

Then again, if Mexico's problem is indeed the size of its public sector—and it very probably is—then the sale of state-owned firms or, alternatively, their liquidation, does not constitute a gamble. It is the only way to go.

—Julio Marquez

Supply-Side Indian Style

NEW DELHI—It may be only a slight exaggeration to call him the Art Laffer of New Delhi. But undoubtedly Prime Minister Rajiv Gandhi, since taking office in late 1984 after the assassination of his mother, Indira Gandhi, is aggressively instigating what Asian Wall Street Journal editor Paul Gigot recently called a "supply-side revolution"—a dramatic policy shift away from India's 40-year journey down the planned-economy road.

Also reporting on the phenomenon recently, The Economist detailed Gandhi's moves toward liberalizing India's economy. He has, for example, cut tax rates: the maximum income-tax rate is down from 62 percent to 50 percent; corporate taxes now range from 50 to 60 percent rather than 55 to 70 percent; and more cuts are planned for next year. Many import duties have been reduced, and various licensing and regulatory restrictions have been eased or removed.

And already, the supply-side strategy appears to be paying off. Though deficit spending is still high, wholesale and consumer prices, for instance, have recently risen at rates about one-half to two-thirds lower than those last year. The economy is growing at an encouraging rate of 4 percent a year, and the Indian stock market is booming. Indian businessmen are eagerly—if perhaps incredulously—embracing the new policies.

Rajiv Gandhi is reportedly committed to taking supply-side reforms considerably further. And if his economic revolution continues with success, the impact may well extend beyond India itself. As Asian Wall Street Journal editor Gigot remarked, "If India—polyglot, poor, non-aligned India—grows with market policies, state planning may have only the Soviets left to recommend it."