The Net Neut

This week, the FCC rolled back the Obama regulations on “net neutrality”.  The deeper we get into the 21st Century, the more different pieces of legislation proposed by both parties start to resemble Ayn Rand’s descriptions in Atlas Shrugged.

Net Neutrality is a convenient way of saying “one price fits all”.  Whether you agree or disagree, I’d encourage you to open your mind up to both arguments.

One thing that nobody really knows is if and when a new technological solution will be on the horizon that will leap over existing infrastructure and deliver the internet to us in a whole new way that is more efficient, faster and cheaper than it is done today.  HFT traders used to use broadband pipes but now use microwave technology now because it is faster.

What I find with public policy and politics from both sides of the aisle is the policy is never ever pure.  It’s always muddy.  In this day and age with so much contempt raging, you need to put aside the politics and focus on the actual policy along with the effects it will have when implemented.  It’s also important to get your emotion out of it as much as you can.  As I have watched the debate rage on net neutrality, I don’t think people have checked their emotion at the door.

I also think there is a big difference between laws, regulations, naturally endowed rights and economics.  For myself, the last two take precedence over the first two.  When it comes to economics, I make sure I know the assumptions before figuring out if I agree or not.  You also cannot make inferences around things.  You have to go to original sources.  An example is that Austan Goolsbee maybe a professor at the University of Chicago but he is no Chicago School economist.  However, because the Chicago School is steeped in the classical tradition of free-market economics and finance, you might assume Goolsbee is a person that believes in that.  From his papers, opinions and actions it’s clear he is a Tobin economist which is diametrically opposed to the Chicago School.

At its core, net neutrality should be a debate about the role of price discrimination and competition.  Personally, I believe in vigorous and transparent competition with very light regulation.  Certainly, we do not have that in communication markets today but it is better now than it was when I was growing up in the 1960s and 1970s.

I want to point you to a couple of things that will enlighten you and help inform your own opinion.  First is an article from The Atlantic that shows the debate between Supreme Court justices Anton Scalia and Clarence Thomas.  What is super interesting here is Thomas and Scalia are Federalists and originalists when it comes to constitutional law.  They try and find out what the original thinkers were intending and try to avoid making law from the bench.  Neither Scalia or Thomas are darlings of the left wing.

Here is the majority opinion that was written by Thomas.  Thomas is a strict constructionist when it comes to the US Constitution.

Here is the dissenting opinion that was written by Scalia.   Scalia was also a strict constructionist when it comes to the US Constitution.

Enough about the law.  What about the economics?  Professor Craig Pirrong is a Chicago economist who teaches at the University of Houston.  He blogged about net neutrality here.  I’ll take out the salient points.  I deliberately challenged him in the comment section on what net neutrality rules mean for startups.  Professor Pirrong writes,

I do not believe that the ISP market is perfectly competitive, but that is a red herring. Even acknowledging the possibility of imperfect competition in that market (although I do believe fear thereof is overblown), net neutrality is not the right way to address it, and indeed, might actually mean that market power is exercised in a way that reduces efficiency. In other words, the Obama FCC wanted to fight ISP market power in the worst way–and it did!

So if net neutrality is an inefficient policy, why did it prevail in the US, at least for a while? That is, what is the political economy of net neutrality?

Well, Chicago has a lot to say about this as well. Indeed, the work of another of my former advisors–Sam Peltzman–is directly on point. Sam’s amazing 1976 JLE article “Towards a More General Theory of Regulation” has an important, but widely overlooked prediction: regulation is likely to occur in industries where there are substantial differences in costs of serving different customers, and that regulated price structures suppress these cost differences. That is, regulated price structures cross-subsidize high cost customers. As Sam put it: “cross—subsidization follows a systematic pattern in which high cost customer groups are subsidized by low cost customers.” And: “The important contribution of politics is to suppress economically important distinctions and substitute for these a common element in all prices.”

That is net neutrality in a nutshell. Put simply, the Obama FCC bought political support Google, Facebook, Amazon, Microsoft, Netflix, et al by implementing a policy that cross subsidized their services. They used the political system to push regulation that suppresses economically important distinctions.

The American Enterprise Institute weighed in here with both sides of the economic argument.

All that is well and good, but personally I still wanted to get grounded more. Where can you turn? I thought that Ronald Coase and Coase Theory would be a good place to start. If transaction costs are zero and property rights are clearly defined, how would Coase look at a policy on net neutrality? I found my answer in this podcast. Coase took on the FCC in 1934, and that argument rings true today. I’d listen to the whole thing, but at the 11:00 mark is where the podcast talks about Coase and the FCC.

My own opinion is the FCC didn’t go far enough.  Coase is correct.  The FCC needs to open up a lot more spectrum and make sure it gets into hands that will use it to compete with existing players.  It would be good to take a look at local regulations from states and cities to see if they restricted competition in any way as well.  My guess is that they almost certainly did.

  • At its core, net neutrality should be a debate about the role of price discrimination and competition.

    Nope, it should be universal service and equal access. After all the edge access ISPs are government granted monopolies using “public” rights of way. Even the licenses they acquired at auction are only good for a certain timeframe.

    Their vertically integrated edge access models are highly inefficient. It would behoove them to share and interconnect as far out to the edge as possible.

    • But price discrimination should give more people access-and if there is a lot of competition there will be more access because demand curves slope down.

      • “if there is a lot of competition”

        There simply isn’t because of layer 1 rights of ways issues and regulation and arbitrary standards controls (Docsis, LTE, etc…) at layer 2. The result is high average pricing. And now the ability to get doubly paid for the same cost element (one from the core content provider and one from the end-user at the edge) which will create even more imbalance and inequity, not less, for the majority at the core and edge.

        The net neutrality term and debate arose when Republican FCC Chairman Powell claimed there was plenty of competition 15+ years ago. There wasn’t. There still isn’t.

        On the other hand look at government mandated interconnection nearly out to the edge as I suggest–Part 15 or wifi–and ask yourself why that part of the public good (considered “junk spectrum” 80 years ago) accounts for 70%+ of all internet access. Imagine if everything at layer 1 were treated the same way.

        We took the wrong fork in the road in 1913 by not mandating sharing and interconnection of public goods and we’re still paying dearly for it.

        Part 15/wifi works. It’s simple to regulate and administer. Once we broadly accept that we need to rethink settlements between actors and networks and how they are mandated and monitored (not set) by the regulator. I call this Universal Service Settlement System. It is more generative and sustainable than the current settlement free, winner takes all model of the internet.

        • Is it a public good? Maybe that’s the question we should be debating? One problem with it being public is the incentives to invest in infrastructure and innovation. Water is a public good; but the infrastructure to deliver and administer water doesn’t change significantly.

          • 2-way telecom networks require ubiquity to be valuable and that requires encroaching on others property rights, so all physical layer 1 networks (wired and wireless) that cross property lines can and should be considered public. Otherwise a market couldn’t develop. (The alternative is that everyone squats or interferes and that is a bigger capital and operating expense than any one player can overcome.)

            In all networks, value grows geometrically with the number of users and is captured at the core, while costs are more or less uniform (with some marginal differences) and grow linearly wrt # of users. The same principles that hold for 2-way networks hold for 1-way, but to a lessor degree.

            (BTW, network theory and network effects dominates everything as we’re finding out. That’s why you can throw most of your reference pieces out the window.)

            All of these things argue for the solution above (mandated interconnection and settlements). Read more here about equilibrism as the answer to the NN debate:

            Everything that’s been created by humanity tends towards monopoly, but that’s not necessarily found in nature. Digital networks (the turbo-charging of information velocity, which is what all technology revolutions have been about) only exacerbate the tendency; contributing to social, wealth and information divides. Ultimately it results in stasis and collapse. We’re seeing that with the Internet right now. Striving for balance, actually a constant state of going in and out it, is what we find in nature. So humanity’s inventions are unnatural. They don’t need to be.