Net Neutrality Axed by the FCC: The Underlying Nature of the Debate
On December 14, 2017, the Federal Communications Commission (FCC) voted to end the Obama era net neutrality rules which had essentially ensured that internet service providers could not segment internet users and attempt to price discriminate with respect to speed of content delivery.
The supporters of this move to end those rules, largely the carriers and providers in the telecom industry (broadly defined), argue that the rules prevent them from investing in innovation in broadband technology and broadening bandwidth networks. Such investments are usually very costly and short term in duration, thus requiring some ability to recover these costs which the net neutrality rules make difficult for them to.
The supporters of net neutrality on the other hand, consumer and public interest advocates and content providers (the Over The Top (OTT) companies), argue that this harms consumers ultimately through internet service provider pricing strategies including increased bandwidth throttling and other similar measures that would now be utilized to restrict service or quality, and raise prices.
So the question that follows is somewhat two-fold: First, are either or both of these legitimate arguments? Second, suppose they both are, how should we decide whose preference should be preferred? Is there a middle ground?
Let me first clear the air by addressing the objective of regulation in a market economy. Quite naturally both the consumer and the business typically have, on face value, opposing objectives. Consumers would like the lowest price possible, and businesses would like... well to sell their product at the highest possible price. These are just summary statements to drive home the point, in a true optimizing sense, it will not always be the highest price or the lowest price that meets their individual objectives.
Regulation is not supposed to exist to get consumers the lowest possible price for a product, rather it is supposed to ensure that certain features of the market do not allow market power to distort prices such that consumers are paying more than the true value for a product or service, or businesses are made to sell a product for less than the cost of providing the product or service, where "cost" already includes the competitive value of the business owners' time and effort in running that business. In other words regulation is intended to ensure that there is a smooth interaction between value, business entry or exit, information provision, and the price mechanism operating in free and open markets.
Now lets get on with it...
The opposing pulls on Economic Growth
At the heart of economic growth, by which we mean an improvement in living standards such that we get to enjoy more and higher quality desired products and services, is the need for incentives. Incentive in economics simply means some sort of reward/punishment mechanism by which we induce behavior toward action in a way that absent that incentive would not have occurred. One of the tenets of economic growth is the ability to develop new ideas. But the development of such ideas by itself may not happen or may not happen as often as we would like if it were not for another tenet of economic growth – the presence of enabling institutions – political, economic, and social. In the right environment, people will invest in creativity and new ideas will materialize and come to fore and economic growth will take place. The right environment provides the incentives for economic growth.
So on this premise we have the first pull which is the basis in most trade laws for patents, copyrights, trademarks and similar. Come up with an innovation and you will be protected for a period of time from competition so that you can reap the fruits of your effort. So political economic institutions that provide secure property rights for such patents incentivize society to create patentable ideas. These ideas drive innovations in economic growth and improve living standards for society in the long run.
However the second and opposing pull shows up here and is the reason for the time restriction – patents enjoy monopoly profits for a period of time, not forever. Why? Because the same incentive that elicits the best from us, also creates room for complacency when there is no urgency to innovate. Worse, strategic behavior also gets introduced where a patent finds a way of extending its life in a perverse manner by blocking both entry and future competition so that economic growth is now stunted. So again good political economic institutions should provide the sort of oversight to prevent this from happening.
Application to Net Neutrality
So how is this all related to the net neutrality debate. It is often very easy for those directly affected to find themselves speaking past each other for reasons aforementioned... it affects the bottom line and our livelihoods. Stripped down to its bare implications, the net neutrality rules potentially keep prices down for internet use, but removing them potentially raises prices.
The proponents behind the argument for eliminating the net neutrality rules are somewhat justified in their arguments. The heavy hand of government regulation does serve to stifle the incentives to innovate – why invest more in creating bigger bandwidth and faster broadband service if they will be constrained from being able to offer this at unique prices to those segments of the population willing to pay for it, and thus cover their costs of providing it? or worse, if nothing prevents OTT voice and content companies from freeriding on the development and offering cheaper services the carriers and service provider companies would have otherwise charged more for, as part of recouping their costs of provision. There is here an argument that high costs and positive spillovers justify the need for lax regulation (market power) to incentivize innovation and cost recovery.
The flip side though is that with the elimination of these rules, there are incentives not necessarily to innovate but for rent seeking through price discrimination and creation of barriers to entry. The service delivery could simply be restructured in such a way that existing speed levels are priced at a premium while speed is cut back for those not willing to pay the premium. They could also stifle their competition from OTT providers by slowing down their services relative to their own content. To avoid the prying eyes of FTC regulators, they could simply modestly improve the speed at which the premium is paid and use multiple other measures to convince regulators that their actions are justified and legal. This is made all the more possible if the industry operates more like an oligopoly than otherwise. They will have little incentive to truly compete with each other but simply create their own similar pricing structures to squeeze out the very last dollar each consumer is willing to pay and not necessarily improve the quality of service to levels hoped for by the policy reversion. So here the consumer advocate groups also are justified in their arguments.
Regulating for Efficiency
The problem here is an age old one. How do we address one form of market failure when the solution proffered creates room for another type. How do we ensure that regulation trades off with a positive net benefit to society these market failures against each other.
With net neutrality in place, we have positive spillovers, and so under-investment and less innovation. Positive spillovers in this context refers to the inability of businesses to recover costs of additional provision of a good even though it provides added benefits that are enjoyed by others. With the elimination of the net neutrality rules, moral hazard could reenter markets and lead to unintended consequences which policy intervention after the fact may find difficult or even unwilling to correct. Moral hazard is the possibility of a party to a 'contract' reneging on their agreement and where such reneging is difficult to observe and punish.
Whenever regulation works in a retroactive manner, it is important that there is a reliable way of determining true costs so that violations can be punished. The end of Net Neutrality moves the regulatory jurisdiction from the FCC to the FTC to retroactively investigate claims of attempts to restrain trade. This is weak as the true costs to these providers is private information. It will be easy for the providers to retain very good lawyers to shoot down any antitrust claims being alleged as the true costs of provision, the extent of innovation, and similar are all privately held information.
Looking closely though, the telecommunications industry already enjoys enormous market power by design as there are effectively huge barriers to entry and there is no question the industry is highly profitable. Many consumers have very limited choice and in many cases have only one or at most two choices for high speed broadband service, so the arguments that relate to positive spillovers harming investments are plausibly fully addressed by the already existing monopoly profits these providers enjoy as compensation and incentives enough to invest, so the first pull alluded to earlier, for economic growth is already in place.
It is more a question of the desire by these firms to monopolize or fully control all aspects of internet use that is likely driving their position and opposition to net neutrality. It therefore makes better sense that broadband regulation be designed in a manner peculiar to this industry and putting in place the net neutrality rules as we had previously should be the way to go. Oversight as provided by the FCC is more prospective and this limits the second pull that detracts from economic growth, we alluded to earlier.
Further Remarks and Predictions
First a word on the politics of policymaking. Net neutrality rules to regulate broadband services as part of the telecommunications industry was passed in 2015 under the Obama Administration. The vote in the FCC was along party lines. The decision to axe these rules has taken place under the Trump Administration. The vote in the FCC was along party lines. Obviously political ideology plays a role in these things and the pendulum will tend to swing back and forth with party control of the government.
What I have tried to do is provide a partisan free perspective on this issue, assuming that the fundamental tenets of a market economy are accepted and proceeding from there.
No oracle needs to be consulted. The gifting of more market power will be used... to maximize profits. In time consumers will get what it is deemed they have paid for, prices will rise for online content, and data speed. The FTC will either stand by idly or engage in costly legal battles which it will likely lose or obtain only modest concessions. Would society as a whole be better off? Very unlikely. Though some will definitely be better off and we know who, this change is a net loss to society.