The Mises Institute monthly, free with membership
Volume 14, Number 6
Hooked by Government
by Timothy Terrell
Government bureaucrats look out for their own kind. Entrepreneur John Shanahan, the man behind "Hooked on Phonics," found that out the hard way when he developed a program that taught his son how to read after the California public schools could not.
Literacy rates in the United States have plunged since government schools replaced the phonics method with the "whole-language" method of the "Dick and Jane" readers. Despite their failure, public school educators have clung to the whole-language method.
The Federal Trade Commission is part of the reason such educational innovations aren't subjected to competitive pressure. Since 1938, the agency has had the power to determine whether an advertisement is deceptive or has "capacity to deceive." What type of ad is deceptive? The eternally truthful government decides.
Federal courts usually stand by the Commission's rulings, so that these unelected commissioners have a fairly free hand in making their decisions. This provides ample opportunity for government-connected firms and methods to be favored at the expense of new businesses and consumers.
As Richard Higgins and Fred McChesney, who both worked for the FTC, have shown, the power of the FTC can be used by large firms to put small firms at a disadvantage by raising their costs of advertising. And when it came to advertising, Hooked On Phonics was vulnerable. For the success of the product depended upon its advertising campaign.
By 1994, nearly everyone in America had heard the Hooked On Phonics radio and TV ads featuring children reading at a level well ahead of their peers, as well as the familiar "1-800-ABCDEFG" toll-free number.
But the FTC was already lowering the boom. After threatening mayhem, the FTC got Mr. Shanahan to sign a consent order stating that his company would not make advertising claims that were not backed up by scientific studies.
Success magazine editors Duncan Anderson and Michael Warshaw report that one of Mr. Shanahan's friends discouraged him from signing, saying, "You'll be signing your company's death warrant. You got the experts mad, and they're setting you up." The agreement sounded innocuous to Mr. Shanahan at the time, but it was to prove nearly fatal.
Mr. Shanahan and the FTC had agreed not to reveal information on the case until December 14, 1994, when the Commission would announce the consent order. But on December 13th, the popular TV show "Dateline NBC" aired a segment attacking Hooked On Phonics, with an FTC official charging that the company had used "deceptive advertising."
Major newspapers carried the story the next day and the response from buyers was immediate and disastrous. Sales plummeted. A class-action lawsuit followed close on the heels of the FTC announcement, and then Dateline did a follow-up hit piece on December 20. In 1995, sales dropped eighty-six percent. Nearly two-thirds of the employees had to be laid off. In October 1995, the company filed for bankruptcy.
Messrs. Anderson and Warshaw report that the FTC announcement provoked heavy, unreported criticism from satisfied customers and others, some of whom believed that the action against Hooked On Phonics portended future FTC attacks on home-based education products.
What was at work here is what economists call rent-seeking. In this case, large firms--say, the public school cartel--use the government to shut off competition from upstarts with better ideas. They secure their market position through coercion. The "educational experts" who testified against him had an axe to grind, but the government lent a sympathetic ear.
Who benefits from the destruction of profitable private businesses and the persecution of honest entrepreneurs? Clearly one beneficiary is the regulatory agency itself, which defends its own existence and budget with the lie that regulation is intended for the good of the public. Most Americans swallow the story, proving in yet another way that government schools are successfully doing what they're really intended to do.
In the Hooked On Phonics case, the public education establishment also stood to benefit from FTC suppression of Mr. Shanahan's method. He had built his company from net sales of barely $100,000 in 1986 to $133 million in 1994, and he was not about to quit because of government bullying.
On the strengths of a satisfied customer base, a revamped advertising strategy, and a two-year study that proves the effectiveness of Hooked On Phonics, Shanahan vows to "come back with a vengeance." He is planning an expansion into foreign markets, a lawsuit against NBC, and a nationwide chain of private schools that will refund the parents' money if the kids don't learn. "We'll put the school boards out of business," Mr. Shanahan says, and he expects sales this year to be well over four times what they were in 1995.
After all, the "whole-language" crowd is beginning to lose ground to intense grass-roots opposition. Recently, after the National Assessment of Educational Progress showed that fifty-nine percent of California's fourth-graders read below the minimum level, the state dropped its nine-year-old requirement that public schools use the whole-language method. And California's reading scores would have been worse if conscientious teachers had not smuggled phonics-based materials (like Hooked On Phonics) into their classrooms.
The Federal Trade Commission's assault would be bad enough were it not typical of the beating that innovative private businesses take from government regulators every day. The incalculable wealth destruction resulting from the strangling of entrepreneurial efforts hurts not only employees and investors, but also children, who may be denied something as essential as the ability to read.
Timothy Terrell is a graduate student in economics and a Mises Fellow at Auburn University