Phone monopolies are slowing down progress on the Internet

If you hit the big one, and find the new piece of software that will take over the market, the rewards are phenomenal

Nerds apart, for most of us the Internet remains baffling. Determined not to be left behind by all this new technology, we may be tempted to log on and try surfing. But some hope. Either the computer is too slow or the lines are too clogged, or we get confused and lost. An attempt to find out the youth unemployment rate in London gets derailed into a tour of the US Department of Labor instead.

It's the future, we're told. That is doubtless right, and the only reason we stick with it. Moreover, it is coming fast. In the four-and-a-half years between July 1991 and January 1996, the number of computers connected to the net multiplied 17-fold.

So, presumably we can expect global competition in such a hi-tech industry to bring all of us the benefits of easy, cheap access, alongside continual innovation and economic growth? Not quite. The development of modern information technology is unlike the neat, competitive process of traditional economists' models. If anything, certain sectors of the hi-tech industry are monopolies, with important consequences for the speed of progress and the distribution of hi-tech rewards.

The costs of missing out on the information revolution are considerable. OECD economist Sam Paltridge argues in a recent edition of the OECD Observer that the Internet provides great potential for improving national competitiveness and economic growth, as well as improving services in health, education and other sectors.

LSE economist Danny Quah goes even further, suggesting that while traditional manufacturing may be in decline, the new industries that will generate improvements in productivity and be the engine of economic growth are in information technology. Getting left behind, either as a country, or as a group within society, is going to be an increasing problem. As Mr Quah puts it, "a vision of the skills-deprived segment of the population becoming roadkill on the information superhighway is overdramatic, but it gets the message across".

But some countries are expanding their access to the Internet much faster than others. And it seems that monopolies at the level of physical infrastructure are to blame. The bottom line for most hi-tech communication remains the old communication networks that have served us so well for so long: our telephones. Internet service providers, such as CompuServe or UK Online, connect enthusiasts to the net, but they do it by renting space on telephone lines. There are plenty of providers to choose from, competing to offer different packages at low cost.

But the phone lines they rent, in most OECD countries, are monopoly owned. And in practice this means that the rental charges are higher.

Mr Paltridge has examined the different charges faced by Internet service providers in countries with different kinds of telecommunication industries. He found that in 1995, the average price for leased line access to the Internet was 44 per cent higher in countries with monopoly telecommunications provision than in countries with more competitive markets.

So what? As Mr Paltridge goes on to argue, higher costs of access are bound to be a disincentive for businesses and individuals using the net. And so it turns out. Countries with competition at the infrastructure level have expanded the number of hosts - computers connected to the Internet - much faster than those without infrastructure competition. Introducing competition into telecommunications could prove critical for economic growth, as well as for consumer welfare.

But even in the privatised sectors of the expanding hi-tech industry there is no guarantee that competition will be sustained. Consider a dominant player that casts its immense shadow over the information revolution: Bill Gates' Microsoft. The company's Windows software is the operating system used on 80 per cent of the world's personal computers.

The brilliant Mr Gates is not just a one-off phenomenon. The nature of these kinds of information industries is that one player can easily become dominant. Economists call the problem network externalities. If everyone else is using Windows, a new business starting up will want to use Windows too. Not only will it make its work compatible with everyone else's, but it won't have to train staff in a different system.

There can be so many advantages to using the same system as everyone else that individuals and companies have no interest in switching to newer and better technology unless everyone else does it at the same time. The incentives for such a dominant company as Microsoft to keep innovating are reduced because there is less competition. As a result there is a genuine risk that, for sound economic reasons, technological progress is held back, and the guy who owns the dominant technology - in this case Mr Gates - cleans up.

But Mr Quah seems optimistic that other pressures for innovation will counteract the problem of network externalities. For a start, the investment needed to generate a technological advance is relatively small. Instead of expensive laboratories and huge new machines to experiment with, all hi-tech innovators need in order to enter the market is their brain and a good computer. Moreover, if you hit the big one, and find the new piece of software that will take over the market, the rewards are phenomenal. Because there are no rewards for coming second, the competitive pressure to come first is even greater.

Mr Gates still faces pressures to innovate too. His new Internet browser, Internet Explorer, has only been developed because Mr Gates failed to anticipate the importance of the Internet. The result was that Netscape with its browser Navigator was able to leapfrog over Microsoft into the new market. Competition is still present, even if there is a tendency for one person to win.

If Mr Quah is right about the overwhelming pressures for progress, then technology will continue to advance rapidly, even if Mr Gates secures most of the profits. Breaking up monopolies may be advisable in telecommunications infrastructure, but less of a problem in the virtual world.

Of course the competition authorities need to keep a beady eye on things. But for the moment we need worry less about the pace and direction of progress and more about the difficult task of ensuring every member of society can benefit from the information revolution.

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