Net Neutrality Rules = Price Controls

by on July 28, 2009 · 27 comments

The FCC has less than seven months to complete and submit to Congress a “National Broadband Plan For Our Future.” Last week, CEI filed reply comments with the FCC on the broadband plan. One of our arguments was that network neutrality rules amount to price controls. ArsTechnica quoted our comments in a recent article and expressed skepticism toward our contention about neutrality mandates:638px-World_War_II_Domestic_Price_Controls

“In particular, [neutrality rules] require ISPs to offer content providers a price of zero, and to differentiate prices to consumers only in certain limited ways,” says CEI’s filing. “The disastrous consequences of price controls are all too familiar. And while neutrality may currently align with industry best practices, that fact limits the possible benefits just as much as the possible harm.”

Content providers pay for bandwidth on the competitive market, so it’s not clear what the line about “a price of zero” refers to (that money is passed along to other ISPs along the network path through the mechanism of “peering and transit“). But it is clear what groups like CEI want from a broadband plan: nothing at all.

Ars is correct in pointing out that pricing based on usage is already commonplace in the form of the well-established system of peering arrangements and transit pricing. But pricing needn’t be based solely on usage; it could also be based on priority levels or quality of service tiers. Such pricing schemes remain in a nascent stage, yet many of them would be prohibited or restricted by neutrality rules. This is because neutrality rules by definition set the price of many kinds of data prioritization at zero. Thus, even if an effective mechanism for differentiating between data streams at the network level were to gain traction, it would be subject to regulatory burdens if neutrality were to be enshrined into law.

Jack O’Connor expands on this argument over at OpenMarket.org:

It’s indeed unlikely that direct payments would be worth the cost to negotiate them. Net neutrality is targeting prices that would probably remain zero anyway, at least for the foreseeable future. But for the most dynamic marketplace in history, etching the business models that prevail today in stone would be unwise — especially considering how often inefficient, outdated regulations impede market evolution.

As Tim Lee explained in a Cato policy analysis last year, the Internet is a remarkably durable network, and any priority-based pricing systems that do emerge are unlikely to endanger the Internet’s underlying openness. Whether or not non-neutral pricing is actually workable, there is simply no case for encumbering it with legal restrictions aimed at averting theoretical harms (or alleged harms that, well, aren’t really harms at all).

  • http://www.facebook.com/profile.php?id=22421341 facebook-22421341

    This is undergraduate economics guys… In a free market with large numbers of ISPs, neutrality regulation would not be necessary. Monopolies, on the other hand, have powerful incentives to:

    1. Restrict quantity to raise price and maximize revenue
    2. Price discriminate

    Network neutrality prevents these two market failures. It is nothing like price controls on goods. Goods markets are generally highly competitive, where the ISP market is intensely concentrated. Network neutrality does not require a given price, it merely requires a uniformity of pricing.

    While the early Internet was characterized by a competitive ISP market, this is no longer the reality. It was the incentives created by this early market structure that prevented these “theoretical harms.” Now expecting ISPs not to leverage their market positions exclusively for their own private financial gain is to ignore the most basic premise of economic rationality.

    The Internet is now an indispensable utility for both the mass media and doing business. Leaving unrestricted control over that resource in the hands of two private firms is unwise in the extreme. Too much is at stake; it is not worth the risk.

  • Ryan Radia

    Undergraduate economics? Fair enough — none of my undergrad econ classes taught the contestable markets hypothesis or the Bertrand model of duopoly competition, both of which are important to understanding the nature of the ISP market.

    You say in regards to Internet regulation, “too much is at stake; it is not worth the risk.” This is precisely how I feel. The Internet hasn't been around for all that long and imposing short-sighted rules runs a very real risk of curbing innovation. Nobody knows what sort of prioritization pricing systems will emerge, if at all, and in 2009 even the smartest people on the planet cannot predict how the next few years of ISP competition will shake out, let alone the rest of the decade.

    You point out that the ISP market is concentrated. Sure, but ISPs really aren't all that powerful in most markets despite their concentration. While ISPs often have enough leverage to operate profitably, that doesn't mean they have a monopoly. Why is it that “net neutrality” has only been abrogated on a handful of occasions? It's surely not because of government mandates — the only official neutrality proclamation that exists is non-binding. Maybe it's because firms generally avoid angering their customers — even in markets where choices are somewhat constrained.

    It'd be great if we had more ISP choices, but there is such thing as too many competing firms in a given market. Entry barriers rooted in government regulation are to blame for the lack of ISP competition in many markets. In other markets, though, the economics simply aren't conducive to having 10 competitors. That's okay, though, because firms must compete not only among existing competitors but also among potential entrants. Go too far, and a new guy will come in and destroy you. That's the risk that ISPs run when they start messing with Internet destinations.

  • http://www.facebook.com/profile.php?id=22421341 facebook-22421341

    No Bertrand in undergrad? That's surprising; we did that and a few others, and this was just at a moderately selective state university. Anyway, I have a few points to follow up…

    Contestable markets assumes low barriers to entry. You state that barriers to entry in the ISP market are created by government regulation. While there are some licensing and other requirements, these are minor when compared to the extraordinary capital cost of physical infrastructure. (I've been part of a group considering market entry, so I'm very familiar with both.) This is characteristic of NATURAL monopoly. The fact that we have two companies rather than one is a historical accident; telephone and cable television infrastructures used to be incompatible, requiring/allowing two separately owned systems. Finally, physical barriers to entry may be lower in places like Manhattan, but most of the U.S. is not so highly concentrated.

    In fact, government regulation, until recently, allowed for EASIER market entry by providing wholesale access to physical infrastructure. However, these regulations have now been weakened and were never applied to cable infrastructure. See e.g. NCTAA v. Brand X, 545 U.S. 967.

    Bertrand is of limited use, mostly for consumers and the headline bandwidth and price number. Content providers must ultimately have connectivity with both providers, and that bargaining strongly favors ISPs. Consumers are unlikely to change their ISP over marginal differences here. If, e.g., X works well but Y does not, your average consumer is not even going to know if only X has paid for priority treatment on their ISP. Therefore, no deal means it is more likely that Y will lose revenue than the ISP, so Y will also pay for priority treatment. ISPs then have an incentive to limit back-end connectivity available to Y should it not pay extra, as well as A, B, and C, who cannot afford to pay what X and Y can.

    Neutrality rules protect innovation, the vast majority of which takes place outside ISPs. They are the platform, not the product.

  • Ryan Radia

    First, I don't believe that last-mile is a natural monopoly. (See Thomas DiLorenzo http://www.lrinka.lt/uploads/files/dir14/13_0.php). Entry may not be cheap, and isn't hit-and-run by any means, so broadband is not perfectly contestable. Yet there is evidence that it is fairly contestable and entry is not all that difficult.

    Consider overbuilders, which were gaining steam until recently (http://findarticles.com/p/articles/mi_m0DIZ/is_…). The big guys kept innovating not just to compete with each other but to ward off overbuilding as well. The threat of the next RCN or Lightwave isn't going away and checks non-neutral behavior.

    Also, I think you be may underestimating wireless broadband as an alternative to wired broadband. Whereas laying wire is expensive even without onerous franchising mandates, wireless broadband is heavily affected by the price of spectrum. Dramatically increase the amount of the airwaves available for flexible licensed use, and you will see a marked decline in entry barriers for WISPs. Tom Hazlett has a lot of research on this subject.

    And ISPs aren't solely beholden to their customers — bad press is bad for stock prices, even if it doesn't translate into any real loss in customers. I suspect the FCC's investigation played some role in Comcast's stock price falling markedly during the latter part of 2007.

    I agree that Bertrand is of limited use, but consumers are more fickle than you'd think. How else do you explain the fairly high churn rate in the broadband market? (http://www.telecompetitor.com/comcast-two-third…) Sure, packet shaping may not be enough to make many people switch ISPs. But doesn't that suggest that maybe most people don't really care about packet shaping?

    Wholesale access, in the short-to-medium run, probably makes ISPs more competitive in terms of the services that they offer across their wires. The problem is that it also creates significant disincentives to take risks — i.e. spending tens of billions laying fiber to homes — and it causes the creation of artificial markets that exist at the whims of regulators, not consumers. It's a great way to encourage Washington rent-seeking, but it's not so good for consumers.

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