The end of Internet history?

By Tim Wu, contributor

“Time has upset many fighting faiths” – Oliver Wendell Holmes

My book, “The Master Switch” asks a simple, age-old question: Is history destined to repeat itself? Is the great revolutionary medium of our times, the Internet, destined to follow the path of its ancestors, radio and the telephone, a path of increasing consolidation and uncompetitiveness, leading over time, to slow stagnation? Or is there something fundamentally different about our times that will keep the network open and competitive for the foreseeable future?

It’s a critical question for any investor, manager or interested citizen of our times, and one that, I think is hard to answer. The design of the Internet truly was revolutionary and we’re much more suspicious of centralized power than Americans were in, say, the 1930s. But on the other hand, neither the laws of economics nor human nature has changed, and both of those elements lead to industry consolidation and empire-building. In short, I think that fifteen years into Internet history, the question remains open.

In contrast, Scott Woolley, Fortune’s reviewer, treats the question as already answered. “A digital switch has been thrown,” Woolley says in his review of the book “and now things are different.” My book is mistaken to warn of potential stagnation in the future, because, he says “the world has ripped itself free of Wu’s grim analog rhythm, in which something good is inevitably followed by something bad.” Rather, because of the digital revolution in our times, “the Cycle is broken. The 21st century will be different.”

You know, I certainly hope that Mr. Woolley is right. Myself, I would be more hesitant to pronounce the end of Internet history. I, like Woolley, have deeply held hopes for a bright future, but as Fortune’s readers know, hope is not a good premise on which to base actual predictions, particularly when you have something at stake.

Much of “The Master Switch” is an argument that things might in fact, be fundamentally different this time around; I just don’t take it as a certainty. First, as I discuss at length in chapter 12, the Internet was a deeply radical invention, albeit for reasons different than usually understood. It’s not just the technical advance that matters, for of course the radio, telephone and TV were revolutionary in their times as well. What makes the Internet different is that it is the first communications system to embody, technically, what I call a “separations principle” – a separation between functions like transport, applications, content and so on. That’s the principle that impaled poor AOL-Time Warner in the early 2000s.

A second argument that things will be “different” has nothing to do with “digitalization” and far more to do with the capital markets. (on NBC’s Press:here, Sarah Lacey of Techcrunch made this argument in response to my book). Today we have venture capital markets exist, in a sense, to fund would-be challengers to stagnant monopolists. To take one example, Skype, which is clearly a challenger to the Bell companies, has attracted plenty of funding from Silver Lake and other investment houses. In contrast, in the 1910s, when AT&T (T) put together its monopoly, Wall Street and particular J.P. Morgan starved Bell’s competitors of credit. In short, the capital markets nowadays aren’t quite so eager to take the side of size.

This point shouldn’t be overstated. Investors aren’t stupid, and if there’s more money to be made in monopoly than challenging monopoly, I think we’d have to assume that’s where the money will go. The public markets have rewarded both Apple (AAPL) and Google (GOOG) as the firms achieved dominant position in their respective markets. And we can overrate venture funding: it is not as if inventors in the 20th century were always starved for credit. Bell and Edison got plenty, and as the book relates, even the American inventor of television, Carl Jenkins, managed to raise millions in a late 1920s IPO, even if his firm was soon crushed by the Radio Trust and the FCC.

The third argument for “different” relies on something much more ephemeral: our attitude toward size and centralization. Unlike now, for much of the 20th century “bigger” and “better” were understood as synonyms. We were a nation in love with General Motors (GM), Robert Moses, and gigantic federal agencies. Put the smartest people in the middle of huge institutions, said Fredrick Taylor the management theorist, and find the “one best way” to do anything. And so it seemed obvious to most in the 1930s, say, that a network like NBC was better than a nation of smaller radio stations, because it was bigger, or that AT&T should run the phone network as a unified monopoly. That was “progress.”

Today, Americans have more of a taste for smallness and decentralization – “small is beautiful”, “buy local,” that sort of thing. Quoting from my book, “in our times, Jane Jacobs is the starting point for urban design, Hayek’s critique of central planning is broadly accepted, and even governments with a notable affinity for socialist values tout the benefits of competition, rejecting those of monopoly.” And so our attitudes toward size is less one of abject admiration, and more one of understandable caution. We’ve been burned by too much central planning: just look at Detroit and Wall Street.

All of the above make for a strong case that the Internet will be different. But it is only half of the story. For the argument that the old patterns of consolidation and domination will repeat themselves is far stronger than Mr. Woolley gives it credit. Rather, he assumes the problem away, based a case study and the idea that “digitalization changes everything.” It does changes some things, but not the laws of economics or of human nature.

Take three economic principles: Network effects, economies of scale and the state of high initial/low marginal costs markets. All three are economic principles that by their nature create dominant firms and market consolidation. And it is pretty clear than none of these effects have somehow been negated by “throwing a digital switch.” Social networking, for example, seems to favor single firm rule, because the more people use Facebook, the more valuable it becomes. The up-front costs of starting a new search engine that can compete with Google have grown, while continued operation of the Google engine is relatively cheap. I could go on.

On the other hand, it is possible that the market, has made it much harder to hold onto a dominant position once established. We’ve all watched firms like Yahoo (YHOO), Microsoft (MSFT), and AOL (AOL) fall from grace. The real question is whether the dominant firms of today will be able, like their ancestors, to create barriers to entry that freeze out their competitors. That depends in part on the economic principles just discussed, but also, interestingly, on whether the internet stays open – whether it remains a platform for new companies to challenge old.

As for human nature. It is a truism that those who gain great power usually take any feasible nature necessary to stay in power, regardless of the consequences for society or their peers. That fact created many problems in the 20th century, and not just in telecommunications. And unfortunately I cannot see why we ought in expect, in our digital age, for people to act any differently. Digitalization, ones and zeros, are neat, but power is still neater. Why should we expect a firm or CEO, having gained power, from trying to keep it? Oh that’s right – “Do no evil?”

Moreover, even though I think Americans are more suspect of size than they once were, we are, if anything, even more slaves to convenience and speed than even our ancestors. As such I think there is at times an unfortunate willingness among Americans to tolerate a dominant firm, even in its abusive side, so long as a reasonably reliable product is delivered. How else can you explain our continued patronage of cable companies?

All this being said, I actually believe we live in something of a golden or silver age in terms of the openness of our tech and info markets. That’s a good thing; the danger with Mr. Woolley’s viewpoint is to mistake what is now for what will always be. What I hope is that readers will come away from “The Master Switch” with a renewed sense of the power of business cycles, and, ideally, a joint determination to, in fact, break or modulate the cycle. The smart money should always be looking for mistakes in the conventional wisdom, and in 2010 our weakness is a blind faith in the idea that digitalization has changed everything.