-10-

sought.10/ In summary, however, we doubt that privacy-as-seclusion will
occupy # major place on the agenda of telecommunications privacy issues,

compared to the three areas we discuss next.

B. Personal Information

No issue in the privacy sphere generates more emotion and concern than
the possibility that information about the lives and habits of
individuals will fall into the wrong hands or otherwise be subject to
misuse. In an interconnected computerized age, there is little doubt
that there exist new technical capabilities for extensive information
gathering, collation, and distribution. Indeed in some cases,
individuals may not even be aware information about them is being
collected. To put the matter in the starkest possible terms: "The .
fundamental problem ... is that the information age will rob each one of
us of one of our more important rights in a free society: The right to
privacy."11/ In the sphere of telecommunications policy, personal
information issues seem likely to arise particularly in connection with
service records of regulated companies, for example, in telephone and
T07 Postal patrons may ask to have their names deleted from mailing lists of
Offensive material. Automated dialing techniques and other unsolicited calls

have moved some people to suggest regulation of such "junk" calls is needed.
See FCC Docket 78-100, Report and Order, May 22, 1980. The FCC has declined
so far to take any major action, Targely because there is no evidence
unsolicited interstate calls (the only calls under FCC jurisdiction) are as
yet a real problem.

11/ Chairman Charles Ferris, Federal Communications Commission, speech before
the Union League Club, New York, October 13, 1980.


-31-

new method.39/ New specific technologies include public-key

cryptography, very large-scale integrated circuitry, and fiber optics.

Rules on Tegal actions open to information protectors play roles
analogous to technology. Laws forbidding (say) wiretapping increase the
of security of telephone conversations.40/ Patents, copyrights, the
common law of trade secrets, Section 605 of the Federal Communications
Act, other statutes, and a number of the rules of the FCC may serve in
similar ways. The effects of such rules will not be simple, however.

To some extent, rules are substitutes for self-protection. This fact
leads to several possibilities. The first is that if a law protecting
information is enforced by public authorities, firms will be able to
relax their own efforts at sel f-protection. The resources they had been
employing for this purpose will now have a higher value in some other
use. In this instance private and publicly provided security are
substitutes. A second possibility is that the two forms of protection
complement each other. In this case the passage of a law enhances the
productivity of the protective activities of the firm, and more private
steps will be undertaken. One example might be as follows: If the law

affords you a remedy, say in the form of an action for damages, you may

397 Technological change can cut both ways, however. Developments in code-
Dreaking and decryption, pther things held constant, will raise the cost of
security, so that less security will be produced at a given cost.

40/ Obviously no claim is made that this or similar Taw provide perfectly
Secure communications, merely that they move in that direction as a first
approximation.


-27-

conclusion that regulation and prior restraint to guard privacy may be
needed more in monopoly and governmental contexts than when one deals
with possible privacy violations by competitive firms or by

ind ividuals.33/

Absent political involvement or monopoly, demands for goverment —
intervention to safeguard privacy may also arise from additional market
failures. Therefore let us examine the potential seriousness of several
alleged market failures that often serve as arguments for government
mandated privacy protection. They include the following: (1) mistaken
or outdated information; (2) stale or superseded information; and

(3) irrelevant or improper information.34/

Recall first that the economic purpose of information gathering in most

cases is to enable correct, jee., val ue-maximizing, decisions. Second,

337" ‘There are two Categories of abuse that we think cut across the four
categories of potential abusers, such that remedies probably should not differ
according to whether the abuser is a goverrment, a monopoly firm, a
competitive firm, or an individual. These two categories are (a) misuses of
(true) information that are illegal under the common and statutory law of
extortion and (b) those intrusions that are essentially forms of trespass.
The laws covering extortion and trespass may well need to be strengthened in
the face of ever-developing computer and telecommunications technologies. If
so, however, we bel feve these remedies should be seen not as part of a new
body of privacy law, but rather as additions to important existing branches of
the tort law.

34/ Stigler, op. cite, at 5. We call them “alleged market failures” not only
Because they are unproven, but also because they do not fit easily into the
economist's traditional categorization of market failures as (a) economies of
scale and (b) externalities. See Section V below, esp. notes 41-47 and
accompanying text.


Vie

~36-

Information is & public good and therefore subject. to important
externalities. Specifically, the producer of information often is
unable to capture the full profits his information might generate.
Moreover profitability, in a competitive market, fs an important measure
of the value society places on an activity. Therefore, the inability of
information producers to profit adequately from their activities may
lead to underinvestment in certain information producing activities, as
measured from society's point of view. The patent and copyright laws
aim, in part, to alleviate this problem. Furthermore many types of
information -- much scientific research, technical data, economic
statistics, agricultural market information, consumer information -- are
produced and distributed primarily by government agencies precisely

because of their public goods characteristics.

When Should Law Enforcement and Other Protection of Rights Be Government

Functions?

One may have a reflex that says, "Law enforcement is always a government
function. Society's decision to follow this approach fs political and
even moral or philosophical. Therefore, economic analysis has no role
here." We would not even be surprised if a majority of economists

subscribe to such a view. But there are economic arguments for


In anaTyzing privacy issues, economics can usefully be taken welT beyond
the costs and benefits of specific information problems. We attempt
below to extend it to the analysis of remedies. For example, whatever
the immediate costs to the economy of restricting the gathering or
transmission of certain information, total long-run costs may depend
upon whether the restrictions are enforced primarily by judicial or
administrative means; whether enforcement is primarily a matter of
government or private action; and whether the remedies are based
primarily on new laws or on extensions of old Jaws (like the patent and
copyright laws or Section 605). Different approaches may use -
significantly different amounts of resources, both public and private,
and they may set up different economic incentives. Hence we see a

potentially fertile field for economic analysis.

Discussions of privacy, telecommunications security, and related policy
issues run the danger of floundering among several different concepts.
The most important concepts for the present discussion are three:

(a) peace and quiet or, in the extreme, seclusion; (b) acquisition,
storage, and dissemination of information about individuals or /
organizations, especially when the individuals or organizations have not
authorized or do not know about such acquisition, storage, or

dissemination; and (c) ability to exclude unwanted parties from access


-46-

Perhaps the chief problem with the second alternative {s that it
probably would not work well unless a government body, like the FCC, set
technical standards for acceptable encryption. Absent such standards,
transmitting parties would have clear incentives to use cheap methods of
encryption, which no doubt could be defeated easily. In effect, the
transmitting parties would be seeking to pass to the government as much
of the protection costs as possible. So we believe the government would
need to set an encryption standard to avoid litigation and “game
playing" about what is or is not “encryption.” An appropriate and
workable standard could then cause profit-making companies to pay
reasonable shares of their own protection costs. Such a distribution of
cost-sharing will strike most of us as desirable on grounds of simple
fairness. And, given the inherent problems of bureaucracies, it will
probably lead to an economically more efficient enforcement regime than
will a systen that relies mostly on government activities simply to

round up intruders.

But the standards-setting solution has at least two possible
drawbacks: (1) The government body that sets the standards probably
will have neither the information, the technical personnel, nor the
decisional flexibility of the private sector, so there is a high
probability government will select a "wrong" standard. (2) Even if the
government selects the correct (i.e., the economically efficient)
standard based on today's technology and costs, there is a substantial

danger that whatever standard it selects will be set in concrete for


~44-

Regulatory control takes a third approach. Certain forms of behavior
may simply be forbidden, perhaps in advance of their ever occurring.
Where certain rights are held by soctety to be inalienable (perhaps in
connection with information about individuals), or when the government
has a clear cost advantage in controlling behavior, the regulatory
approach may constitute a reasonable (or perhaps the best) tack.59/ But
it is hampered particularly by inflexibility (consider the unwieldy
requirements of the Administrative Procedures Act, which often delay
even small rule changes by a year or more), by all the problems of
bureaucracy, including often destructive political pressures, and by
chronic and serious information problems. Direct control should be a
sort of "last resort," only after a strong showing that common law,
statutorily-based judicial remedies, and patent- or copyright-like

approaches are infeasible or otherwise undesirable.

A final approach is for the government to abstain. The effect of this
(non-)policy is to grant everyone a hunting license for information,
signals, and the like. Anyone who wishes some degree of information
privacy or communications security will have to provide it for
himself. Where private provision of security is the least-cost method,
and where the costs of using courts and commissions to protect property
rights are high, no policy may be the best policy.
397 For a further discussion of the various rules for protecting entitlements
“see Guido Calabresi and A. Douglas Melamed, Property Rules, Liability Rules,

and Inalienability: One View of the Cathedral, 85 Harvard L. Rev. 1089(1972),
esp. section III. ~ ~~


-50-

approaches to patent and copyright, Tike patentability for encryption
chips and copyright for encryption algorithms, or other new concepts of
Property rights in both personal and Commercial information, sometimes
provide more cost-effective safeguards to privacy than either regul ation

or private tort actions?


-42-

commission. The judicial approach assumes competition will normally
protect consumers’ interests, so that government intervention can be
limited to (a) occasional structural changes to strengthen competition
and (b) after-the-fact penalties and injunctive relief for abuses
competition does not prevent. As long as competition in an industry
does in fact "work" most of the time, then it seems self-evident that
the judicial approach will usually consume fewer public resources than
will continuous regulation. And we think it reasonable to assume,
unless logic and evidence strongly suggest otherwise in specific
instances, that judicial remedies wil] not impose greater private costs

than will administrative regulation.57/

Some remedies currently available help illustrate these points. The
common law allocates to the individuals most directly concerned the
responsibility to respect the rights of others, as well as the right to
seek redress if one's rights are invaded. It is highly empirical, in
that it generally takes action only upon presentation of factual
evidence that some offense has truly occurred. In particular it does
not seek to ban in advance an entire catalogue of hypothetically
possible abuses that may or may not be likely to happen. It can be
tailored to fit particular situations and relies on incentives directed
at the various parties’ self-interests. Sometimes the method used is to
BIT These and related issues have been discussed frequently in both the legal
“and economic literature. See, e.g., A. D. Neale, The Antitrust Laws of the

U.S.A, (1960), esp. chaps. 12-15; or Clair Wilcox, Public Policies Toward
Business, 4th edition, (1971), passim.


-14-

consequence is that most, perhaps all, individuals wil] be poorly suited
to their jobs. Productivity will be low, and as a consequence
employment, wages, and incomes will all be lower than would be the case
if information about worker characteristics were allowed to influence
the job assignment. Analogous arguments can be made for credit,
insurance, and other services. Therefore, before one criticizes any
particular information-gathering practice or recommends Tegal
restrictions upon it, we believe he should analyze carefully the

economic functions that practice may serve.

2. The Distributional Impact of Information Restrictions

There will also be effects on income distribution from the prohibition
on information gathering. Consider the employment case. If firms are
not allowed to collect detailed information about specific
characteristics of individual employees, they will still learn the
average productivity of the people they hire and will of necessity base
wage decisions on this inferior knowledge.17/ The result will be a
"leveling" effect, whereby highly qualified people will receive lower
wages and less desirable positions than they could otherwise command,
and modestly endowed individuals will receive benefits beyond those an

unimpeded market would provide. So there will occur a transfer of

\

177 We are again, as elsewhere in this paper, abstracting from the problem of
Tisk.


-32-

be more likely to mount a search for an intruder on your privacy than if
tt does not. Im any event, there is always an incentive for @ firm to
seek government assistance in providing protection. Where the costs of
a court action are low and can easily be assigned to the parties
involved, there may be a good case for the government to create a
private right of action. In other instances the desirabil ity of
governmentally provided protection will depend on the costs of providing
and enforcing rules and on how the burden of those costs will be

distributed if the government is the protector.

Economic Reasons for Government to Supply or Regulate Goods and Services

The commodity or service we have labeled communications "security" can
be provided by governments, by private entrepreneurs and business firms,
or by some combination of the public and private sectors. There is a
well established body of theory, primarily developed in that branch of
economics called "public finance," that offers guidelines on the roles
of governments as (a) suppliers of goods and services or as

(b) regulators of their production and sale.41/ The situations where

intervention (via either regulation or outright government ownership) is

i7 That Ts, guidelines for governments that wish to be economically
efficient. In this paper, we have chosen not to analyze situations where

governments are mainly pursuing goals other than economic efficiency.
However, we suspect that the explicit pursuit of such goals would not
substantially alter our conclusions or the mode of analysis we present in this

paper.


I.
Il.

Ill.
IV.
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VI.

Vil.
VIII.

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Table of Contents

Abstracts cescscccececccccccsoecavasssaereessss essere es
Introductionsscccsccecscavcessvooesccsrseressees essere ee
The Economics of PLIVACYsccacveveccesscsccsossreeeseeee®

Ae Seclusionsceeceeee

B. Personal Informationsacecccccsccscccccrssscesreesee®

1. The Economic Value of Personal
Informationssccccccccsecesccencsvesceserseere®

2. The Distributional Impact of
Information REStrictionSsssrcessececsererscerrr®

3. Privacy as a Consumption GOOd co veccccvccecsovees

4. Voluntary Versus Involuntary
Provision Of Informationssscccsssccceseseceee®

C. Commercial and Industrial Privacyeccsessccescecveses
D. Theft of SErviceesccsccccccccceccsccsssorsesseeeeee®
The Demand for Information SECUritYscvecccceccssesecees
The Supply of Information SeCUritysecesececcscsccrorooe®

Economic Reasons for Government to Supply
or Regulate Goods and ServiceScccecescccscerscccsssees

When Should Law Enforcement and Other
Protection of Rights be Government

FUNCEIONSseecccccccccsccessscsccsacsrsesseeeree rere ee
The Economics of RemedieSescceccssccccccccesesssceooeses
An Application of Economics to Remedies.secccesscoeceees

Concluding Thought S.oesescccceecsccccssssorssssereerrrr®

Page
ii
1

7

8

10

1

14
5

uv
20
22
24
30

32

36

40
45


~25-

protective investments.31/ Even though many important costs of
protection or threats may not be measurable, we think this framework is
useful for analysis. Furthermore, we suggest society can generally be
looked upon as constantly making such cost comparisons, if only
implicitly. That is, enactment of any new law restricting data access
implies a legislative judgment that the estimated costs imposed by the
restiction are less than the ultimate total costs of the abuses it would

stop.

For the purpose of demand analysis, we reclassify potential invasions of
privacy into two large categories: (a) where the intruder is a
government, or an organization or individual seeking information for
essentially political purposes; and (b) where the intruder is an
organization or individual acting without political motives. Non-
political intrusions may be motivated by commercial ends, by “idle
curiosity," or by extortion and blackmail. Commercial intrusions may be
subdivided according to whether they are done by (1) monopoly firms or
(2) competitive firms.

317, We stress our Broad view of costs, both for protective measures and for
Threats. For example, a particular law or regulation may require no direct
investment costs, yet the costs it imposes may be substantial over the

long run in terms of lost production. Such situations involve what the
economist calls “opportunity costs." And the ultimate costs of threats to
security may be direct monetary costs, opportunity costs, or (non-measurable)
psychological costs.


-ll-

cable television. We think the aspects of personal privacy we discuss
next may well be relevant in analyzing the appropriateness of new

privacy regulations in an emerging technology like interactive (two-way)

cable.

1. The Economic Value of Personal Information

Information is essential for most personal and business dealings. Life
is pervaded by contacts and various relationships with other people, and
we could not (indeed most of us would not) have it otherwise. We deal
with friends, employers, lenders, goverrment offices, merchants, and a
host of others. In all these cases, we engage in transactions -- the
obligations of friendship, personal services, money, and the like. In
order for these transactions to be-efficiency-increasing, it is
important that the terms of agreement and exchange be understood by all
parties involved. And the parties must have (at least imp icit)
understandings about enforcement.12/ But since it is neither possible
nor desirable to have complete and fully enforceable understandings, the
participants normally acquire at least some information about one
another. The amount of information will depend on the complexity of a
relationship, its expected duration, and the degree to which each party
has to rely on the other.13/

JZ7_This does not necessarily mean compelling the completion of the terms of

a contract; it simply requires that full damages be paid in case of breach.

13/ "Amount" may have both a quantitative and a qualitative aspect.


-17-

4. Voluntary Versus Involuntary Provision of Information

Another major personal privacy issue ts the extent to which the
provision of information about an individual is voluntary. There are
three possibilities. First, information may be obtained in a clearly
coercive way. Most pure examples are in government settings; for
example, we are all required to disclose financial information to the
IRS and a wide variety of personal information to the Bureau of the
Census. The requirements are absolute, conditional only on our
citizenship or presence in the United States. There are penalties for
noncompliance, and no right of information privacy is recognized by
society in this context. (That is, we are not allowed to keep certain
information from IRS or Census. But they, in turn, are subject to heavy

restrictions against release of personal information.)

A second, but less extreme, case occurs when we deal with a
monopolist. If the service we are purchasing has only a few or very
poor substitutes, we may have no choice but to provide highly personal
information to the supplier. An example might be a credit bureau (if
credit is as essential as some feel) or the telephone company. The
“compulsion” stems from the fact that doing without the service in

question would be very costly (the substitutes are very poor).

Whenever there is monopoly, there is a greater probability than under

competition that too much information will be gathered. The reason is


-13-

similar matters. The essential economic point is that resources may be
used inefficiently in the absence of sufficient information to evaluate

them properly .14/

For example, suppose a law (or court decision or administrative ruling)
moves a certain category of information into an “unrequest able"
category. The former user can (1) disobey the rule, thereby incurring
costs if the rule is enforced 15/, or (2) he can avoid it by turning to
substitute (legal) sources of information. These new sources will
necessarily be of poorer quality.16/ In either case, the net effect is

likely to be lower productivity and (total) income.

Consider another example: Suppose an employer simply assigns job
applicants to positions in the order that vacancies occur and as people
apply for positions. That is, he does it in an essentially random

fashion, making no use of information about the applicants. The

147 George Stigler, An Introduction to Privacy in Economics and Politics,
University of Chicago Center for the Study of the Economy and the State,
Working Paper No. 010-1 (1979), at 13.

15/ The expected costs for a risk-neutral individual will be the penalty for
Violation multiplied by the probability of being convicted.

16/ If the new sources were of equal or better quality, they would have
“already been used by @ profit-maximi zing firm. Since the new sources are not
perfect substitutes for the old ones, costs rise, Yess information is
gathered, and the quality of decision making declines. Thus the availability
of alternative information sources does not alter the earlier point concerning
efficiency loss. The objection that the information formerly collected was
irrelevant to proper decision making is dealt with later in the paper. See
Section VI.


-26-

Although there are many exceptions in specific cases, we think as a
general matter that abuses by individuals and competitive firms will be
most amenable to judicial remedies and self-protection. On the other
hand, we think abuses by governments, by others acting with political
motives, and by monopoly firms are most likely to require administrative
remedies ("regulation"), prior restraints, and public expenditures. Our
reasoning basically is that governments (which essentially are
monopolists -- their most important monopoly being the right to use
coercive violence) and monopoly firms have weaker incentives to protect
information properly than do competitive firms. Furthermore, we suspect
individuals acting without organizational support (including the
computers and telecommunications equipment that normally are too
expensive for individuals) simply do not constitute a massive threat to
pPrivacy.32/ Competitive firms that do not protect information about
their customers or that do not provide secure communications channels

will, if there is widespread public demand for privacy, have

difficulties surviving in the marketplace. Customers who want certain
kinds of privacy, like unlisted numbers or assurances that buying habits
data or mailing lists will not be sold, should be able to shop arourd
for companies with reputations for discretion. But when a monopoly firm
or @ government does not provide the level of protection the individual
wants, then the individual may have nowhere to turn. Hence our

327 Although opinion polls show a high level of public concern over privacy
Tssues, we are aware of no systematic research that satisfactorily documents
the problem.


corporations and others to protection from unauthorized appropriation of

information transmitted by electronic signals.8/

A. Seclusion

The phrase "the right to be let alone" is the first formal expression of
a right to privacy in English or American law.9/ It connotes one's being
able to control his immediate environment (home or office) for
uninterrupted reflection, repose, recreation, or relaxation. Of course,
total seclusion is usually not desired or achievable; even Howard Hughes
had to deal with a few intermediaries to achieve his goals. Yet there
are at least two kinds of "economic" reasons why some right to seclusion

is usually deemed appropriate.

First, “intellectual” workers and other "thi nking" individuals require
freedan from noise and interruption. Therefore some people may need
private offices. Anyone who has worked in a high traffic, open area
will confirm this point. It is important to note that this reason is an
"instrumental" argument for privacy -- the protected individual becomes
more productive as a result. From this point of view, privacy has no
independent raison d'etre. The demand for privacy in this case is

87 Tt seems the right of privacy, narrowly defined, pertains to individuals;
a corporation traditionally has not been able to claim a right to privacy as
such. See Prosser, ibid., at 815.

9/ Cooley, Torts, 2d ed. (1889), cited in Prosser, ibid., at 802.






2

-23-

and paying customers are provided with a decoder or special receiver.
Anyone who can obtain such equipment from another source can also
receive and use the signal -- without paying. Such opportunities
present obvious problems for the providers, but thus far it has proven
difficult to enforce property rights in broadcast signals before the

courts.

The troubles of MDS (mul ti point distribution service, which operates at
microwave frequencies) and subscription TV (STV) provide examples.
Entrepreneurs such as "pirate Electronics" (a recently formed Arizona
corporation) market decoders so that receiver owners can watch the
subscription programs without paying. At the moment the Tegal status of
this practice is uncleer .28/ Courts in Detroit and Phoenix have granted
preliminary injunctions barring the sale of unauthorized MDS
instruments; but in a Los Angeles STV suit, it was held there was no
cause of action in airwave piracy.29/ As a consequence it is not known

definitively what Tegal rights of action exist to protect entertainment

signals. The issue also presents a problem for cable and potentially

87 The Tpractice” has two aspects: (1) the viewer taking the signal off the

Fir and decoding it with his own “black box" and (2) selling the decoders

thems
also.
obvio
actio

29/

elves. If the first practice is legal, then presumably the second is
It is not clear that if (1) were illegal then (2) would be also. For
us enforcement cost reasons, the STV industry has chosen to bring its
ns mainly at the manufacturing level.

Business Week, September 29, 1980, at 44. The distinction seems to hinge

on the fact that the FCC treats STV as a form of “broadcasting” and MDS as a
common carrier service. Broadcasting is not covered by Section 605, but
common carrier services are covered.


-20-

When the price mechanism is functioning efficiently, employers that
place excessive demands for information on employees wilT have to pay
higher wages, and therefore they will have incentive to collect only
information truly useful to them. Similar arguments hold for insurance,
credit, banking, or any other market, including markets for various
telecommunications services. That is, competitive pressures normally
will encourage businesses to collect only information with real economic
value. So government-mandated restrictions on information will tend, in
workably competitive markets, to reduce national income. Whether there
is a case for government intervention depends on (1) the extent of
market failure and (2) the likely costs and benefits of government.
action. We think intervention should be justified only on a case-by-

case basis, always with the awareness that one man's privacy may be

another man's lost wages.

C. Cormercial and Industrial Privacy

Commercial and industrial privacy raises somewhat different prob] ems
fram personal privacy. In no sense is commercial privacy a consumption
good. Its importance is entirely instrumental. That is, it is most
Properly regarded as an input to product fon.25/
257 We recognize that it, may be difficult to distinguish the demand for
commercial privacy from the demands of owners and managers for personal

privacy. For a general discussion of the problem of owners’ and managers‘
goals ina firm setting, see Armen Alchian and Reuben Kessel, Competition,

Monopoly, and the Pursuit of Money, in Aspects of Labor Economics, National
Bureau of Economic Research, Special Conference Series, Vol. 14, Princeton
University Press (1962).


ABSTRACT
ECONOMICS and TELECOMMUNICATIONS PRIVACY:
‘AMEWORK for Y

This paper is an overview of privacy, particularly as related to
telecommunications policy, from an economic perspective. The general
framework is the economics of information. Information about people and
organizations is a val uable economic input to decision making. Moreover,
privacy also may be analyzed as an economic good insofar as resources devoted
to the production of privacy must be taken from elsewhere. That is, more
privacy usually means less of some other good or service.

Because the value of information often depends on its security and
because information about both individuals and organizations can be used in
inimical ways, society has valid concerns about invasions of privacy. Many
fear rapid change in communications and data processing are eroding privacy in
ways unimaginable only a few years ago. One result has been a series of
legislative proposals to regulate information gathering, use, and
dissemination.

Seclusion, personal privacy, business or commercial privacy, and
theft of telecommunications signals each involve different privacy problems.
Seclusion (the right to be let alone) is valued for its own sake, yet it may
conflict with desires of others to communicate with an individual. Personal
information privacy may be threatened especially by electronic data storage
and transmission and by availability of detailed customer records for services
like interactive cable TV. But information privacy is neither simple nor
straightforward. Privacy for individuals may mean less information for others
who deal with them. So it may reduce economic output. Thus, any legislation
affecting the flow of personal information may have far-reaching, and not
always desirable, effects on productivity and income distribution. Somewhat
different, and perhaps less emotional, concerns apply to commercial and
industrial privacy. In particular, firms often legitimately need
confidentiality for management data, production processes, strategic plans,
and the like. Therefore, business privacy may tend to increase economic
output, at least in competitive industries. Signal theft has additional
implications for the economic viability of many forms of telecommunications
particularly in the entertainment area.

Factors affecting the supply of communications security include
technical progress as well as Tegal changes. Both offer hope for more privacy
in some areas, even as they threaten it in others. On the demand side, market
failures can bring pressures for government to provide more privacy or
security. Problems seem to arise most often when the information handler is a
government or a firm with some degree of monopoly power. The claim that firms
will use mistaken, stale, or irrelevant information is examined for both the
competitive and monopoly cases. Fears along this line are probably less
justified for the competitive case than for monopoly.

-ii-




-9-

derived from the demand for final goods and services. If we treat
privacy (peace and quiet) as an intermediate good, it seems doubtful
that substantial government intervention is required. It will be in the
employer's interest to provide appropriate working conditions, based of
course on the costs of doing so. To the extent workers independently
desire additional privacy, it can be one of the fringe benefits in the

overall wage package.

Second, privacy in the sense of seclusion -- perhaps as temporary
withdrawal from the cares of society -- can also be desired for its own
sake, that is as a consumer good. The increased demands for wilderness
experiences in recent years presumably reflect desires for such
solitude. But seclusion, for whatever end, is not a free good, and
consequently we can never have all-we would like. For example, wrong-
number phone calls intrude on us. But to guarantee their elimination
would require ridding ourselves of the phone or hiring an answering
service -- both expensive alternatives. An unlisted number provides a
certain degree of protection against unwanted phone calls, but only at
the cost of reduced ease of access to the subscriber for other people.
Even protection from unsolicited advertising or computerized dialing
techniques involves a cost since sellers would have to turn to Tess

efficient methods of reaching potential customers.

Privacy as a consumption good is protected to some extent by postal

regulations, and similar protection from "junk" phone calls has been


The paper reviews the economic rationale for government intervention
and suggests that only when markets cannot work because of external effects,
public goods problems, or economies of scale is there a compelling case for
intervention. The need for police-like enforcement of Taws in the
telecommunications privacy/security area therefore is not always obvious.

A wide variety of remedies, only some of which require direct
regulatory intervention, are available. The common law, privacy statutes,
patent and copyright protection, administrative regulations, and sel f-
protection are all possible solutions to information privacy and security
problems, but they have different direct costs and different effects on
economic incentives. There are good reasons to believe judicial enforcement
of private rights of action often can be economically more efficient than

administrative remedies as means of strengthening telecommunications security
and privacy. .

-iii-


-15-

wealth from more highly qualified individuals (as well as customers and

owners of firms) to the less qualified.

This distributional aspect of privacy says simply that there are strong
economic incentives for some individuals to contro] personal
information, in order to cast themselves in the best possible light.
Indeed, Posner has argued that much of the so-called desire for privacy
is in fact a nani festat ion of this proclivity.18/ However one feels
about the overall importance of this determinant of the demand for
privacy, it will clearly be important in at least some circumstances.
Thus, proposals for systematic increases in records privacy should be
scrutinized to analyze the effects on income distribution as well as on

the economic efficiency of labor and product markets.

3. Privacy as_a "Consumption" Good

While the previous (implicit) argument against legal restraints on

information collection seems to us fairly compelling, it is not

yy Richard Posner, The Economics of Privacy, Regulation, May/June 1978, at
2.


Federal Communications Commission: ;
Office of Plankand Policy” ©
. 1910 MStreet, A.W:
~~ Washington, D.C, 20854



-38-

scattered, out of touch with one another, and maybe even dead. Each
knows only a small piece of the puzzle. Furthermore, the economic
payoff to a single victim who investigates. a crime successfully and
obtains a conviction would normally be very small in relation to the
costs of investigation, apprehension, and prosecution. Only
investigators whose activities span a large number of criminal incidents
are likely to have enough information to "put it all together" at a cost
society would find acceptable.50/ Hence the possibility of substantial
scale economies in investigation is one important argument for
government contro] of the "natural monopoly" called "law

enforcement .."51/

Potential free rider problems for law enforcement arise perhaps most
Significantly in the deterrence of crime. Consider a mythical village
of fifty homes and no public police force. If, say, forty-five
homeowners should contract with private security companies to patrol
their properties, then we think the remaining five homeowners would
Probably get “free rides" and could feel relatively safe against thieves
and other assorted criminals--especially to the extent that the free
50, 7K though private enforcement of criminal laws is generally forbidden
expressly by statute in the United States, many crimes are simul taneously
torts. E.g., the crime of theft is also the tort of conversion. But in
addition to the costs of investigating and prosecuting such torts, the victim
is likely to find the thief has few readily attachable assets! See Landes and
Posner, op. cit.
51/ The reader may wish to Ponder why police departments in the United States

‘developed as branches of government rather than, like telephone companies,
regulated public utilities. But see note 53 below.


-2-

tnformation yield to the same kind of economic analysis as decisions to
Purchase other factor inputs: A competitive, profitemaximizing firm
will purchase information up unto the point where the expected payoff
from the last bit of information equals its expected cost.1/ Some
privacy statutes increase the costs of certain types of information or
forbid their use altogether. 2/ Other statutes, like Section 605 of the
Communications Act, tend in effect to decrease the costs of information
or -- what is the same for economic analysis -- the costs of using

certain information.

The domain of this paper is avowedly economics. Thus we focus mainly on
costs and economic efficiency. We know other aspects and goals are
important in the privacy arena. But we think these other factors do not
diminish the relevance of an economic analysis of privacy, for at least
two reasons. First, non-economic goals almost always have economic
consequences -- usually net costs but sometimes net benefits. Second,
many of the social norms governing us, including privacy norms, have

arisen at least in part because they have always had economic

T7 A simllar analysis can be applied to privacy viewed as a consumption
good. An individual will purchase additional privacy as long as the
additional (private) benefit exceeds the additional (private) costs.

2/ To forbid the use of a certain factor input is to increase its cost to
Fnfinity. Therefore the economics of information can treat the effects of the
latter privacy statutes simply as special cases in a generalized cost-oriented
framework.


I.

Economics and Telecommunications Privacy:

A_Framework for Analysis

Introduction

Privacy, and legislative proposals and academic writings about its
protection, is today a veritable growth industry. The news media
reflect almost constantly a concern that modern tel ecommunications,
computerized data banks, and other products of the electronics
revolution make intrusion so cheap and convenfent that governments and
businesses will be tempted to violate individual privacy on a scale
never before contemplated. Less visible to the public eye has been a
serious dialogue among government, business, and academic Jawyers,
engineers, and cyberneticists on the costs and other hidden drawbacks of
various proposals for greater privacy. Yet systematic, published
economic analyses of privacy issues have been rare. Moreover, we know
of none devoted to telecommunications privacy issues. This paper is a
first step in developing an economic analysis of privacy for

telecommunicat ions.

Our approach draws upon the “economics of information,” which treats
information basically as no different from the economy's other
productive inputs like land, labor, and capital. Just as an economy
needs labor, it needs information. And just as entrepreneurs invest in

(physical) capital, they invest in information. Decisions to purchase


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-34-

controls, society might benefit from their being organized as
monopolies. The reason is that unit productton costs wiTT be Tower
under monopoly than under competition. But an uncontrolled monopolist
presumably would charge a price far above his actual production costs.
Hence the common argument for government licensing and control, or

ownership, of natural monopolies.45/

"Externalities" exist when the producer of a good or service does not
bear the full social costs of his productive activities or when he does
not reap fully their profits. Pollution is the most common example of
the former. Invention and other innovative activities are common
examples of the latter. For instance, the economic incentives for
research and development may be weak in areas where the difficulty of
enforcing patent protection does not allow inventors to capture large
rewards for their work. This possibility leads to the argument for
government management of activities like agricultural research, where
effective patent protection is often virtually impossible yet where

social benefits may be potentially enormous .46/

45/ The arguments for government ownership vs. regulation may hinge upon
Political considerations, incentives for economic efficiency, or a
combination.

46/ And, of course, the patent system is itself an important type of
regulation -- albeit not “public utility" regulation -- and an important
alternative to direct government ownership of research and devel opment
facilities.


-22-

A further government role may be hard to defend, unless there is
convincing evidence of a Specific market failure. A firm can be
expected to take protective action up to the point where the additional
Cost of doing so is equal to the additional benefit. Spillovers of
either costs or benefits seem unlikely. So if one sees a fim
transmitting proprietary information over an unencrypted channel, for
example, he is probably justified in bel ieving the benefits of

protection simply are not worth the cost.

D. Theft of Service

A fourth problem is intrusion upon a communications system to intercept
and use subscription entertainment signals. While one may tend not to
think of this matter as a privacy issue, it shares a number of features
amd potential methods of solution with other telecomnunicat ions

intrusions, particularly those related to commercial privacy.27/

Some firms provide signals intended only for paying recipients.

Normally these signals are encoded or difficult to receive in some way,

277 In fact, the authors believe that for most analytical purposes there is
Tittle reason to distinguish between theft of entertainment services and theft
of commercial and proprietary information in electronic form. We make the
distinction here merely because it has to date been conventional in most
discussions of telecommunications security, even though both entertainment
signals and point-to-point information channels are protected primarily (and
without distinction from one another) by Section 605 of the Communications

Act.


239-

riders can conceal their identities from potential criminals.52/ We
submit that such free ride potentials are a major justification for
today's accepted approach to criminal law enforcement, 1.e., virtual
government monopoly.53/ And in parallel to our discussion of scale
economies immediately above, we think the case for government provision
of law enforcement services is also weakened where a substantial free

rider problem is not demonstrable.

Undoubtedly there are cases involving telecomnunications or information
privacy where scale economies and free rider arguments justify some
measure of government enforcement of criminal taws, as in the example of
the mythical village just discussed. But we believe these issues should
be approached on a case-by-case and technology-by-technology basis. We
are particularly unwilling a priori, and without strong logic or
evidence, to accept the notion that government enforcement should be the
general case in matters involving telecommunications privacy. In

summary, we are skeptical that police-like law enforcement in the

527 Note that all the homeowners, not just the five free riders, have an
“Incentive to conceal the free riders’ identities in order simply to reduce the
village's overall attractiveness to outside thieves.

53/ A third reason for government monopoly in law enforcement, beyond the
rationales of scale economies and free riders, has been advanced by

Landes and Posner, op. cit. Their argument is that private, competitive law
enforcement "firms -- Tike the bounty hunters of yore -- will invest too many
of society's resources in law enforcement and therefore will be economically
wasteful. Although we have no major quarrel with the Landes/Posner analysis
on its own terms, given their tightly confining assumptions, we are not
convinced their "bounty-hunter" model applies in any important way to
telecommunications. So we do not concern ourselves here with their arguments.


-21-

Certain classes of information are explicitly recognized as proprietary
and are protected by the patent, trademark, and copyright laws. Patents
have a seventeen-year period of protection, to encourage above normal
returns to new processes and hence stimulate innovation. If competitors
are free to copy a new method without delay, the incentive to invent may
be diminished.26/ The copyright laws offer similar protection to
authors and composers. Again, the protection is justified in terms of
the overall benefits to society. Analogously, trademarks play useful
social roles by carrying signals on the quality of goods and assigning

responsibility for defects.

Business firms may also have secrets not protected by patents or
copyrights. For a variety of reasons, such protection may not be
legally available for certain classes of information, or the firm may
prefer nondisclosure of some process or product. To the extent these
secrets are valuable to the firm and to society, there is a societal as
well as private interest in their security. Strategic plans, new
product devel opments, bids, prices, planned responses to competition,
and many other things fall under this rubric. Common law and statutory
law recognize 4 right of privacy in trade secrets and offer remedies if
the security of @ firm is breached by certain methods. For example,

industrial espionage is punishable by Taw, and properly $0-

Be This is basically an enpirical question, on which the evidence is
equivocal.




-12-

For example, a restaurant normally gathers no information about a patron
other than what can be obtained by a casual glance. If the customer
wishes to complicate the transaction by charging the meal, he will be
required to identify himself, and information about his current credit
status will be gathered. At the other extreme, an individual seeking a
high-level, sensitive position must reasonably expect that he will have
to provide a great deal of information about himself and that it will be
subject to cross-checking and verification. Indeed, in the latter case,
what constitutes relevant information may not be definable or
specifically targetable in advance of the actual data gathering. A
“background” check constitutes, from some points of view, just such a
“fishing expedition.” It is intuitively clear that there will be at
least some cases where very extensive information gathering is
justified. Can we identify the kinds of information likely to be of
interest and the conditions under which the correct amount of
information will be forthcoming before of the data collection itself?
Even raising the question suggests that for some purposes, it is hard to
imagine any reserved area of privacy, save in the confines of one's own
mind. To take the extreme case, if the CIA is recruiting a double agent
it will attempt the most probing information gathering conceivable. The

interest will surely extend to political views, sexual proclivities, and


-49-

by-case basis, however, to persuasion by logic or strong evidence. At
this stage in our research, we have not examined as much of the relevant
literature, evidence, and law as we would prefer. But we note with
interest that the industries most prominently mentioned in the
literature on privacy and most frequently encountered in privacy
legislation -- credit, banking, insurance, health, and government -- are
either heavily regulated or tend otherwise to have monopolistic
characteristics. In tel ecommunications specifically, we think privacy
Problems are less likely to arise from failures of competitive markets
Ber se than from the monopoly structures imposed by regulation-and other
government policies. To evaluate the needs for additional goverment-
imposed privacy safeguards in tel ecommunications, we suggest addressing
the following series of questions: (1) Is the specific concern at issue
likely to cause a significant problem in a competitive market? (2) If
not, is the relevant market monopolistic or workably competitive? (3)
If the market is not workably competitive, can it be made so? (4) For
markets or industries where competition is not likely to solve privacy
problems (i.e., where there truly are significant market failures), then
are continuous regulation or other forms of administrative intervention
the best remedies? Or (5) would stronger rights of private action, via
the courts, seem to offer solutions at lower total social costs? And
(6) for situations where competition-via-deregulation is ruled out by
technical or political factors, is more regulation necessarily the
answer? Or (7) can stronger rights of private action be usefully

superimposed upon existing regulatory systems? Finally, (8) would new


decision.37/ Perhaps firms do fail to maximize profits in situations
Tike this, or are simply irrational, but the incentive to earn high
profits is a powerful, force against using improper information. An
alternative hypothesis 1s that the information alleged by some to be
irrelevant is useful at least to some degree. George Stigler notes
that, as usual in this kind of argument, there 1s no evidence presented
for either side.38/

The use of irrelevant or improper information may be simply a variant of
the second problem if the firm is a profit maximizer. If, however, the
firm discriminates on the basis of sex, race, or some similar
characteristic, things become much more complicated. In particular, if
race, sex, or similar characteristics are irrelevant to productivity,
there is then a pure discrimination problem that society may wish to
deal with as such, rather than as a privacy matter. We suspect some of
the more extreme privacy concerns about “irrelevant” information may be
overdrawn; but since there is so little knowledge on the subject, we

remain open to new evidence.

377 If information is gathered centrally (as by credit bureaus) and provided
Tn its entirety, a report.may contain information not of use to a particular
subscriber. It may be cheaper for the information firm to send out a standard
package rather than tailor the product to each request. A profit maximizing
user will simply filter out (ignore) information irrelevant to its purposes.

38/ Op. cit., at 7.


Vv.

-30-

To sum up our view of the demand for privacy, we think the felt needs
for privacy safeguards are likely to be strongest in governmental and
monopolistic settings and weakest in competitive markets. And

specifically we are skeptical that such alleged "market failures” as
mistaken, stale, or irrelevant information are likely to be pervasive
where competition is healthy. Therefore we would not be surprised if
society should allocate most of its “privacy protection resources” to

the government and monopoly sectors.

The Supply of Information Security

Information security is produced from a variety of inputs, employed in
ways determined by costs and available technology. At any time there
will be a number of techniques available, including coding, encryption,
physical protection, audit trails that reveal who has had access to
sensitive information, procedural rules for employees, and legal
remedies. These techniques may be as simple as remembering to lock the
door, but others are “technical" in the ordinary sense of that term.
Thus, a change in knowledge (say, in mathematics) may make feasible and
widely available protection that could not have been contemplated ten
years ago. Specific new technologies will always have the effect of
lowering the costs of protection. They may seem inexpensive in some
absolute sense, but “they will never be adopted unless they are cheaper
than other technologies. If an older method is truly a cheaper way of

providing a given amount of security, it will not be superseded by the


“45-

VIII. An Application of Economics to Remedies

Let us consider alternative remedies for unauthorized intrusion upon a
radio system.60/ Such a system might be used to convey point-to-point
messages (either for common carriage or for one company's internal
data), subscription entertainment services, or other information.
Assume a modified version of Section 605 that would offer government.
protection against unauthorized reception-cum-use of radio signals only
when the transmitting parties encrypt or otherwise scramble their
signals.61/ We treat two main forms of government action: (1) a
statute that allows enforcement of private rights of action through the
courts, i.e., lawsuits that would allow plaintiffs to seek damages or
injunctions against offenders; and (2) police-like government activities
to apprehend offenders and seek criminal penalties against them.62/
Economic analysis can help explain the differing efficiency consequences

of these alternative remedies.

607 We take a radio system to be any wireless communications systems that
uses the radio spectrum, including television, data, and voice.

§1/ Section 605 of the Communications Act, prohibits unauthorized reception-
Cum-use (or divulgence) of signals under Federal jurisdiction. It does not
distinguish between wireline signals and signals that use the radio

spectrum. Our example, however, makes such a distinction implicitly. We
would not necessarily apply the arguments of this section to wireline signals.

62/ For purposes of analysis, we discuss these two alternatives as if they
were mutually exclusive, although in the real world they might easily be
complements.


-18-

that the element of compulsion allows the collector of information to
shift some fraction of the costs onto the Provider. Since the demander
is not paying the full price of the information, he will tend to demand
@ larger quantity than is justified in view of the real social costs of
Providing it. The government seems likely to be the worst offender:

the SEC collects reams of (mostly irrelevant) data about companies, the
ICC about the details of railroad management, the Federal Reserve on the
details of certain financial transactions, and the list is endless. In
None of these cases are the costs of data collection and transmission in
the agency's budget; hence, there is little incentive to take account of
the true cost.22/ The failure will be less serious, but still present
to some degree, in the case of the private monopolist. His requirements
for information raise the price of doing business with him and reduce
his sales; this reaction puts a partial limit on Monopolist's demands.
Monopoly can be thought of as a kind of market failure in this case. It
is well to note, however, that failures of this type usually originate

in goverment itself or in the requirements it imposes on others.

The third situation occurs when information about individual A is
transmitted to B, who in turn passes it on to C. The second

transmittal, if it takes place without permission or in contravention of

227 There are at Teast two reasons why. First, the agency is typically not a
‘profit maximizer, so even if the cost were in the agency's budget there would
still be no incentive to optimize on the same basis as firms. Second, higher
costs might simply be used to expand an agency's size and range of tasks
performed internally.


IX.

-48~

tmposed technical standard woutd turn out to be the effictent

sol ut fon.) (2) Firms would simultaneously have incentives to search for
the most economic trade-offs between encryption and prosecution. This
balancing between encryption and prosecution costs would not occur if
responsibilities were split between the private sector and a government
“communications police" agency. It is a well-accepted proposition in
economics that such internalizations of resource allocation decisions
are generally efficiency-increasing and hence are economically

desirable, in the absence of complicating factors like scale economies.

Thus economic analysis suggests that, in the absence of important scale
economies or externalities, a judicial approach to the protection of
encrypted radio signals is likely to be more efficient economically than
an administrative, police-like approach. We think the reasoning is
equally valid whether signal security is needed in a particular instance
for personal privacy, for commercial privacy, or for protection of

subscription entertainment service.

Concluding Thoughts

It is not obvious to us that competitive markets will fail most of the
time, or even much of the time, to provide consumers and workers with

the "right" amounts “of privacy -- 1.e., the amounts of privacy they are
freely willing to pay for in the form of higher product prices or Tower

real wages, or in the form of higher taxes. We remain open on a case-




-37-

government management of much law enforcement .48/ They are grounded in
the traditional economics of public finance (outlined above in Section
V). The two most important arguments relate to economies of scale
(especially in investigation) and free riders (especially where
deterrence is concerned). Significant scale economies or substantial
free rider problems in law enforcement may then constitute sufficient
(but not necessary) conditions for public management. 49/ Conversely,
we think the case for government provision of law enforcement services

is weakened where important scale economics or externalities are not

demonstrable.

For an example of scale economies, consider the area of criminal
investigation. Because the professional criminal tends to repeat @
successful crime and thereby establish a modus operandi, there is a high
probability that investigators will detect a pattern leading to

apprehension. But victims of the repeat criminal are likely to be

487 Tt should be recognized that the virtual government monopoly in
enforcement of criminal law is a relatively recent phenomenon in Anglo-
American jurisprudence. For example, private bounty hunting was common until
the late nineteenth century as a means for apprehending criminals. And
English law still allows private enforcement against certain classes of crime,
Tike shoplifting. Almost all private enforcement of criminal law has been
legislated away in the United States. For a fascinating survey, see William

Landes and Richard Posner, The Private Enforcement of Law, 4 J. Legal Stud. 1
(1975).

49/ Landes and Posner, Ope cit., argue that public enforcement may be
‘preferred to private en ‘orcement even in the absence of scale economies and
free rider problems, due to the phenomenon of “overenforcement" in certain
contexts. It is important to note, however, that their objection to private
enforcement in such cases is economic rather than political or moral. See
note 53, below.


-35-

"Free rider” situations are a special class of externalities, and they
often involve "public goods." Public goods have the characteristic that
one person's consumption does not diminish potential consumption by
others. For example, compare a loaf of bread to the Washington
Monument. If I eat the bread, you cannot. But if I look at the
monument, I diminish neither the services it provides nor your ability
to consume them. Hence monuments are public goods and loaves of bread
are not. The inability of firms to restrict access to and hence charge
for public goods means they normally will not supply such goods -- at
least not in amounts commensurate with the benefits they confer. So
public goods often are owned or produced by the “public" through its
government. For example, fire prevention is usually treated in cities
as a public good, due to a free-rider problem. In a crowded city
without a fire department, most homeowners might buy fire protection
fron private entrepreneurs. But the non-purchasing homeowners will also
receive substantial safeguards if most of their neighbors buy
protection, simply because the major fire hazard in a crowded city is
probably the spread of conflagration from building to building. Such
free riding strikes most of us as blatantly unfair; moreover it may be
economically inefficient. And it provides a rationale for governments

to operate fire departments .47/

.

477 An obvious alternative would be to require every homeowner to contract
With a suitable firm for fire protection. This line of analysis does not
hold, however, for suburbs and rural areas where there is little danger of
fire spreading from building to building.


-5-

to a telecommunications system.5/ Furthermore, the second concept may
have quite different implications depending on whether one is dealing

with individual or organizational privacy.

Economic analysis is relatively straightforward for the first and third
concepts and, some might say, less interesting than for the second.
Briefly put, peace, quiet, and seclusion can be not only important
"inputs" to production, particularly for “intellectual” work, but also
important “consumption” goods. And anti-theft provisions, which are at
the heart of the third concept, seem absolutely essential for
information-based and communications-based industries, in the same
manner that our economy could hardly function without protection against
physical theft. Therefore, it is the second concept of privacy that

receives most attention below. (See Section II.)

Telecommunications privacy might seem at first glance to cover only @
minor subset of the issues involved in privacy per se. The field of
issues is much larger, however, to the extent that telecommunications
includes matters like computer-to-computer Tinks and penetration of data
bases via electronic communications. Regulatory policy at the interface
of telecanmunications with computers is evolving rapidly, and it is not
37 An Important group of. unwanted parties includes non-paying users of
Subscription entertainment media like pay TV. Although such theft-of-service
issues are not viewed by most experts as privacy matters bee se, they are
generally thrown together with privacy under Section 605 0 ‘the Communications

Act of 1934. Moreover, we think they are subject generally to the same sorts
of legal and technical remedies as are privacy matters.


-47-

years, despite having been superseded relatively soon by new technical
possibilities. Such inflexibilities in technical standards today plague
much of U.S. telecommunications policy, in our opinion.

A judicial approach offers promise of @ more flexibile and efficient
remedy. Assume that our modified Section 605 would allow transmitting
parties who encrypt to go before the courts and seek relief against
unauthorized reception, but that it would Provide no additional
government role. Further, it would in no way attempt to define
encryption or set technical standards for it. What would then be the

results?

We foresee, most importantly, two interrelated outcomes. (1) Firms
would have weaker incentives to “play games" with the definitions and
levels of encryption.63/ They would be led by the profit motive to get
about the business of finding the encryption systems best suited to
their own signal characteristics, transmitting technologies, financial
positions, and customers. (Note that these factors, especially
customers, might vary across the country even for a single service like

MDS. Such diversity makes it even more improbable that a Washington

637" Attempts to adopt trivial or ineffective encryption systems would
Probably tend to be self-limiting, insofar as they would force the
transmitting firms to spend more and more resources on detecting and suing
Signal thieves. We think this process would probably lead then to adopt
meaningful encryption methods rather soon, as Tong as they knew a Federal
Communications police force would not take on the enforcement burden and bail
them out.


-7-

useful remedies where misuse of information by authorized persons is the
main problem or where society may not wish to allow certain data to be
gathered or maintained in the first place. In an important sense, then,

privacy is a broader issue than security.

II. The Economics of Privacy

According to Prosser's classic exposition, the invasion of privacy in
law is not a unitary concept, but consists of four different torts
united only by a common term. He distinguishes (1) appropriation of
name or likeness, (2) intrusions, (3) public disclosure of (true)
private facts, and (4) false light in the public eye-7/ We think a
different breakdown is appropriate for analysis of telecommunications
privacy issues. We shall discuss matters under the following four
headings: (a) seclusion, or intrusions upon personal peace and quiet;
(b) personal information, a heading that deals to some extent with all
four of Prosser’s categories, plus a set of activities he did not
consider tortious, namely the gathering of or access to certain personal
information without intrusion or where no clear misuse has yet occurred;
(c) commercial and industrial “privacy”; and (d) theft of services via
“intrusions” into telecommunications systems. Therefore we go beyond

traditional legal privacy notions and consider the rights of

7 William Prosser, Handbook of the Law of Torts, 4th ed. (1971), at 804.



December 1980

Economics and Telecommunications Privacy:
A Framework for Analysis*

James A. Brown, Jr.
Kenneth Gordon

Office of Plans and Policy
Federal Communications Commission
Washington, D.C. 20554

¥ The opintons expressed in this paper are the authors’. They do not
necessarily reflect policies or views of the Federal Communications Comnissfon

or any other organization or individual. We are particularly indebted to
Doug Webbink and Nina Cornell for many helpful suggestions.


228=

keep in mind what 1s meant by market failure. In the case of mistaken
or outdéeted information, there {s failure {f an information-gathering
entity fails to correct an error when either the subject or the
information purchaser would be willing to pay a price in excess of the
cost of correction. While this kind of market faflure is imaginable,
there are strong incentives for firms to keep the problem within
bounds.35/" Inaccurate or outdated information leads to mistakes, and
mistakes hurt profitability or the achievement of other goals. No firm
wishes to accept bad customers (or employees) and turn away good ones.
The information firm that supplies bad information will itself soon find
that it is losing customers .36/ While perhaps almost everyone has heard
horrendous examples of this type of error, we have seen no systematic

evidence to support the notion that it is widespread.

The second type of error, the use of stale information, represents a

somewhat different type of market failure. The standard example is the
use of an old (10 years, 20 years?) arrest record to deny an applicant a
Job or credit. The implicit inference is that the potential employer or

lender is unable to filter out the information most useful for his

357 Of course, the error rate will never be zero. The reason is that the
costs of insuring a zero error rate would exceed the benefits.

36/_ If the information firms' customers cannot detect the bad information
sufficiently quickly, a problem may remain. They may learn of false “goods”

more rapidly than false “bads”. Failing to hire good employees shows up only
indirectly, and in the long run, in the form of a reduced ability to compete,

whereas bad employees will be detectable reasonably quickly.


-16-

conclusive.19/ Privacy for its ow sake may legitimately be desired by
soctety.20/ If so, the ineffictencies generated in labor markets,
credit markets, and elsewhere may simply be regarded as a price we must
pay for a desired service. But we should always remember that there are
no free lunches: more privacy means tess of something else. And in the
absence of any independent method of valuing privacy as a consumer good,
there may be no good way of knowing precisely whether the cost is
commensurate with the benefits derived.21/ In analyzing privacy
proposals for teleconmunications, or any other industry, the body

politic should not neglect these complications.

197 We are not discussing the methods by which a given class of information
Ys collected. Clearly, some of the possible means of collection are seen by
society as impermissible. And among commentators like Posner, who express a
great deal of skepticism about many current proposals on privacy, we know of
none that question basic prohibition against wiretapping, trespass, and
similar intrusions.

20/ For the moment we abstract from the potentially serious problem of narrow
Tnterest groups seeking "privacy" protectfon for themselves in contradiction
to the overall societal interest. If there are public goods aspects to the
provision of privacy, the problem is magnified even further.

21/ On the other hand, for modestly qualified individuals to receive benefits
Beyond those a well-informed market would bestow, as well as the reverse,
cannot be defended on any fairness criteria we know. And there are other
dimensions to the efficiency effects. Extensive information gathering may
inhibit the production of illegal goods and services. On the other hand, it
may have a "chilling" effect on the consumption of legal, but morally
ambiguous, goods and services (e.g., abortions, pornography).




-40-

general area of telecommunications and informat fon ‘privacy is likely to
offer many significant advantages over a well thought out system of
self-protection and private enforcement. This hypothesis is bolstered
by our belief that digital electronics technologies may soon reduce

encryption and self-protection costs significantly .54/

VII. The Economics of Remedies

The need to conserve law enforcement resources is general -- not limited
to telecommunications issues or to privacy. Moreover, this need
encompasses private resources spent for security and enforcement of
rights, as well as public expenditures. The latter point seems to us
especially important. A policy that simply shifts the costs of
Protection from the public to the private sector is not necessarily good
if, for example, it should also cause a large increase in the total

(public plus private) costs of information security.

547 Our skepticism about economies of scale in enforcing communications
‘security laws parallels a relatively new skepticism among regulatory
economists about natural monopolies and economies of scale in many tmportant
areas. For years, and until recently, the notion of scale economies was often
accepted uncritically, without evidence, as the main reason for government.
intervention in a host of industries. But, we believe, such routine belfef in
natural monopoly is fading. Cf. FCC Docket 20003, Second Report, January 9,
1980, esp. paras. 108-118. Also, Nina Cornell, Dante! Kelley, and

Peter Greenhalgh, Social Objectives and Competition in Common Carrier
Communications: Incompatible or Inseparable? Working Paper No. 1, Office of
Plans and Policy, Federal Communications Commission (1980).


~24-

for satellite broadcasting.30/ Until this issue is decided (probably by
legfstation) , Perhaps the phrase “unauthortzed use of service” fs better
than "theft of service." The real issue(s), we think, should not be
“theft ," but (a) the circumstances where subscription media are
desirable components of a Communications package, (b) whether it is
necessary or desirable that non-payers be excluded, and (c) who should
be responsible for policing. On the last point, it is by no means clear
that governmental authorities are necessarily in a better position to
Provide signal security than the Programers themselves via encryption

or other self-protective means. (See Sections V and VIII below.)

III. The Demand for Information Security

Individuals and society normally should want to pay for security or to
seek new laws guarding privacy only when there are real threats of
intrusion or information misuse. That is, one can imagine almost an
infinite number of abuses; yet it is impossible to protect against all
of them. Therefore individuals and society face substantial allocation
questions in deciding where to invest their limited resources in
physical security, legal protections, or simple (but not costtess)
caution. The greatest threats, measured in terms of their total

monetary and non-monetary costs, presumably deserve the greatest

30/  K number of states have al ready enacted antipfrating statutes for cable.


-33-

usually deemed appropriate all come under the broad heading of "market
failure." The two main categories of market failure are economies of

scale and externalities .42/

Economists generally assume most goods and services are produced under
conditions of increasing costs ("diseconomies of scale") or constant
costs ("constant returns to scale"). Industries that produce such goods
or services are candidates for competitive organization.43/ But on the
other hand, industries that produce goods or services under conditions
of decreasing unit costs (“economies of scale") are candidates ‘for
monopolistic organization. These industries are the so-called "natural
monopolies" -- often thought to be public utilities like electricity,
telephone service, and railroads. We hasten to add that this
conventional wisdom has undergone a good deal of questioning in recent
years.44/ But if indeed such industries are characterized by scale
economies, it is at least conceptually possible that with proper
47 Some recent Titerature identifies "economies of scope" as another
category that justifies government intervention. To the extent this
categorization is valid, we think its policy implications in our present
context are not significantly different fran the implications of scale
economies. Therefore we do not treat economies of scope as a third category
of market failure. See W. J. Baumol, On the ‘proper’ Cost Tests for Natural
Monopoly in a Multi-Product Industry, 67 American Economic Review 809 (1977).
43/ We shall not give an explanation here. The routine argument may be
found in any standard economics principles textbook. See, for example,
Paul Samuelson, Economics, 9th ede, McGraw-Hill (1973), at 147-161.
44/ See note 56 below; also cf. Nina Cornell and Douglas Webbink, Common
Tarrier Regulation and Technological Change: The New Competition in the

Communications Industries, U.S. Congress, Joint Economic Committee,
forthcoming (1981).


-19-

an implied agreement of confidentiality, may involve a type of
compulsion. The feature that distinguishes this situation from the
previous one is that the information in question has already been placed
in the hands of a second party. If there is a problem, it is probably
better viewed as one involving an incompletely specified agreement
between A and B or as an enforcement problem in contracts.23/ Whether
A had a right to rely on B's discretion {s of course an issue that could

be litigated.24/

In competitive situations, that is, where all parties have a reasonable
range of alternatives, there is a much stronger presumption that the
amounts of information provided and received will be the “right”
amounts. Providers of information will be able to purchase the desired
degree of privacy (perhaps by accepting lower incomes or Tower product
quality) and demanders will also get the information they want {possibly
by paying higher wages or prices). Those with strong preferences for
privacy will work for firms where little personal information about
employees is needed. Those with fewer concerns about divulging facts on

themselves will face a richer array of job opportunities.

FEY] Perhaps because it is too costly to contract more completely or to
enforce contracts of the type.

identification tag), there may be a violation of a privacy expectation.
Similarly, if a credit card company discloses your purchase patterns to the
other merchants, a problem may arise. A primary problem in these instances,
of course, is that it may be difficult to know whether the information has
been revealed.


-3-

consequences -- even though those consequences may sometimes not have

been particularly obvious either to our ancestors or oursel ves.3/

Let us state the case for the economic analysis of privacy in a slightly
different way. To say that a specific privacy proposal increases the
costs of certain information, even that it increases it to infinity, is
not necessarily to condemn the proposal. Many important decisions in an
area like privacy will, and perhaps should, remain "political" insofar
as the public and their representatives wish to see them taken almost
regardless of cost. Economic analysis should strive, we believe, to be
neutral and aim chiefly to shed light upon the costs and benefits of
specific policies. 4/ Me think better knowledge of cost and benefits
can lead to better policy decisions, whether or not the measurable costs

exceed the measurable benefits.

37° Economic analysis of "non-economic" institutions has been especially
prominent in the work of Gary Becker and his colleagues. For samples, see
Becker, A Theory of Marriage, 81 J. Pol. Econ. 813 (1973); idem, Crime and
Punishment: An Economic Approach, 76 J. Pol. Econ. 169 (1968); or Anyra
Grossbard, Economic Analysis of Polygyny, 17 Current Anthropology 701

(1976). The first formal applications of economic reasoning to the non-
economic institution(s) called “privacy” are, SO far as we know, in two
important articles by Richard Posner, The Right of Privacy, 12 Georgia L. Rev.
393 (1978); and Privacy, Secrecy, and Reputation, 28 Buffalo L. Reve 1
(1979). We draw heavily on Posner throughout Section II below.

4/ It is commonplace to observe (a) that neither economics nor any other
Social science can ever be 100 percent neutral about. policy issues and (b)
that economists (and therefore economics) often are flagrantly biased on all
sorts of issues (not all of them "policies"!). We agree. Nonetheless, we
think that by "striving," both economists and economics are frequently able to
achieve neutrality for all practical intents and purposes.


41.

It is tautologically true that where there are no economies of scale or
externalities in providing security, the total costs of a decentralized
private security system will be no greater than a totally public system
or a mixed system.55/ Furthermore, as a practical matter, we think a
private system will tend to have lower total costs for at least two
other reasons: (1) public systems are likely to suffer from problems of
bureaucratic inertia and coordination, given their lack of profit-and-
loss incentives; and (2) private systems allow people and firms to pick
only the amounts of security they feel they need, rather than impose a

uniform (highest common denominator?) cost on everyone.

Judicial enforcement of privacy rights seems to us preferable to
administrative enforcement (i.e., continuous regulation) in industries
and markets not characterized by scale economies or externalities in
either the industry's production per se or in provision of
information/telecommunications security.56/ This distinction
corresponds generally to that customarily made between industries where
antitrust is the primary means of economic regulation and those where

regulation is (in the United States) primarily by independent

557 We are prepared, as noted above on p. 39, to grant the possible existence
Of market failure in provision of telecommunications and information security
on a case-by-case basis. But we do not think market failure is pervasive or
inherent in our areas of concern.

56/
‘does

Note that the mere existence of externalities or other market failures
not by itself provide a sufficient argument for government

intervention. There must also be a showing that regulation or other
government intervention would improve the situation, at an acceptably low

cost.


-43-

define a property right, for example, in some aspect of privacy. Or
often it simply allows an action for damages when someone is injured by
the act of another. The principles of the common law are sufficiently
broadly conceived to be highly cost-effective in many contexts and
applicable to a wide range of circumstances.58/ But where the cost of
using the courts is very high, for example because it is difficult to
bring reliable evidence to the adjudicative procedure, or in cases where
the underlying structure of an issue is changing very rapidly, judicial

enforcement of remedies may be less attractive.

Copyright and patent law take a Somewhat different approach. Here the
entitlement is always protected by a property right. Where transactions
are easily arranged, and after-the-fact eval uations of the right
uncertain, the law generally requires that use rights be arranged in
advance. It is noteworthy that when advance arrangements are hard to
make, as in the performance of music, the copyright systen becomes
complicated to administer and a basis of costly contention between the

claimants to royalty revenues.

587 0n this subject, see generally Richard Posner, Economic Analysis of Law,
Bd ed., Little Brown, (1977), §8-2 and chap. 13. We follow Posner in
classifying as "common law" not only law made purely by judges, but also any
statutorily-based judicial enforcement of private rights that has the same
evolutionary characteristics as common law.


-6-

clear to us whether public policy in the coming decade is likely to, or
should, draw a strong disttaction between “computer privacy" and
telecommunications privacy. Therefore, we do not separate then
rigorously in this paper. Moreover, issues concerning the service
records of regulated companies like common carriers and two-way cable

systems potentially involve almost the entire range of personal privacy

issues discussed below in Section 11.6/

It is useful analytically to make a clear distinction between “privacy”
and "security." The two terms are often used interchangeably, «and this
practice may lead to confusion. We take privacy to be a particular
state of being or outcome (though not necessarily an end in itself). We
take security to be a collection of devices and actions (including laws)
that prevent unauthorized access to particular communications or
information. Security devices and actions can at best provide remedies
for only a subset of privacy violations -- those where unauthorized

access is the main problem. But note that security may not provide

6/7 The main Communications technologies that may raise privacy concerns
Fnclude (a) common carrier and other telephone and records transmission
systems; (b) interactive video cable and similar two-way household systems for
data retrieval and query; (c) cable, subscription, and pay TV and similar
entertainment media (whether utilizing the radio spectrum or cables for
distribution); (d) standard broadcasting; {e) data bases accessible by radio
or cable communications; and (f) private radio services not included in the
foregoing list. In the category of "cable" communications we include not only
coaxial cables but also optic fibers, ordinary twisted-pair wires, and other
transmission lines. Categories (a) and (b) are, we think, the most {mportant
for our discussion and subsume such services as electronic funds transfer,
electronic mail, and computer-to-computer communications. Category (c)
includes "theft-of-service” issues.