During the heyday of the telegraph, in the mid-1800s, companies competed for state and municipal franchises that gave them exclusive rights to operate transmission lines in designated markets, Aaron Honsowetz of Bethany College writes in a Promarket article.
Governments used the franchise agreements to generate revenue or protect consumers, says Honsowetz, an associate professor of economics at the West Virginia school. In some cases political corruption was involved.
Telegraph companies had every incentive to maintain this system because of the competitive advantage that securing a state or local franchise gave them, he says. Rather than focus on research and development, telegraph companies were expending resources “lobbying municipal and state governments for rent-seeking entry barriers.”
The California Telegraph Company, for example, won a 15-year right from the state of California to operate a line between San Francisco, San Jose, Stockton, Sacramento and Marysville in a deal that kept out every other telegraph company.
Blocked companies would need a workaround if they wanted to get into a market. The Franklin Telegraph Company, for example, had trouble securing a franchise to New York City in 1865, “so they elected to merge with The Insulated Lines Telegraph Company, who already had a telegraph franchise in the city,” he said.
The focus on protecting the franchise system changed when John Sherman, the Ohio senator known today for the Sherman Antitrust Act, proposed and helped pass the Post Roads Act in 1866, which allowed companies to construct and operate telegraph lines along any post road in the United States in exchange for giving the federal government discounted telegrams – in effect, giving the companies a national franchise that enabled them to bypass the hurdles states and municipalities were imposing.
“The Act realigned incentives for telegraph companies away from lobbying municipal and state governments for rent-seeking entry barriers, which now had lower rates of return, toward pursuing research and development,” he said.
With their state and local monopolies at risk, companies shifted their competitive focus to improving the technology of their telegraph lines.
Since the onset of the telegraph age, Honsowetz says, a wire could only carry one telegram at a time. Now a race was on to find ways to expand bandwidth so a wire could handle multiple telegrams at once.
“Increasing the carrying capacity of a telegraph wire by a factor of two or four represented an opportunity to dramatically increase the number of messages a company could handle without having to systematically string new wires,” he said.
Elisha Gray, who went on to co-found Western Electric, and Alexander Graham Bell, working separately, experimented with ways to carry telegrams in harmonic tones that could then be converted into telegraph signals.
“Each tone generated on a telegraph wire enabled a new channel to transmit additional telegrams on a single wire,” he said.
Out of these experiments, the two inventors developed the technology that led to the telephone, with Bell winning patent battles over Gray to claim the title as the father of the technology.
“The telephone changed the world,” Honsowetz said. “Hence, antitrust via the 1866 Post Roads Act changed the world when it spurred innovation in the telegraph industry.”
The moral of the story, according to Honsowetz, is that progress comes from companies competing on innovation rather than trying to protect markets with “rent-seeking” entry barriers.
The Post Roads Act, Honsowetz said, “demolished the ways the government, local and state, were rewarding entrepreneurs for fighting for political favors rather than investing in the improvement of the products and services the people used.”
