I continue to be mystified by the contention of some Net neutrality advocates that it is not a form of economic regulation.  The reality, of course, is that Net neutrality would ban business models and necessitate price controls. If that ain’t regulation, I don’t know what is.  As Robert Litan and Hal Singer note in their new Harvard Business Review essay, “Why Business Should Oppose Net Neutrality,” “Non-discrimination under the FCC’s net neutrality proposal means that ISPs cannot offer enhanced services beyond the plain-vanilla access service to content providers at any price.”  Thus, any type of service prioritization or price discrimination would be prohibited under the FCC’s Net neutrality regulatory regime.

As I explained in this earlier essay and in the video below, this would be a disaster for investment, innovation, and consumer welfare. Differentiated and prioritized services and pricing are part of almost every industrial sector in a capitalistic economy, and there’s no reason things should it be any different for broadband. As Litan and Singer note, “The concept of premium services and upgrades should be second-nature to businesses. From next-day delivery of packages to airport lounges, businesses value the option of upgrading when necessary. That one customer chooses to purchase the upgrade while the next opts out would never be considered ‘discriminatory.'”

And let’s not forget, something has to pay for Internet access and investment in new facilities. Differentiated services can help by allowing carriers to price more intensive or specialized users and uses to ensure that carriers don’t have to hit everyone – including average household users – with the same bill for service. Why would we want to make that illegal through Net neutrality regulation and the misguided price control schemes of a bygone regulatory era?

Panel #2 at this year’s “State of the Net” pre-conference featured a lively debate about net neutrality and investment. It included a debate between Hal Singer of Empiris LLC and Michael Livermore of the New York University Law School. It also featured the comments of Markham Erickson of the Open Internet Coalition and Christopher Yoo of the University of Pennsylvania Law School.  The panel was ably moderated by Susan Crawford.  Here are some highlights of what proved to be a fun and feisty debate, which began with the comments of Hal Singer:

Hal Singer, Empiris LLC

• FCC wants to constrain pricing flexibility for networks
• Not clear we need price regulation for service delivery in absence of clear market power
• FCC offers novel “collective action” theory to justify regulation, but doesn’t make sense and doesn’t apply here
• Investment at edge of network will not decline in absence of Net neutrality regulation
• Outlawing priority delivery would discourage investment in new networks AND applications
• “Net neutrality would harm the very folks it seeks to protect”; end users will see price hikes
• Investment at core is crucial

Michael Livermore, New York University Law School

• says there is market failure that justifies Net Neutrality regulation + positive externalities with regs
• w/o Net neutrality rules there will be under-investment at both core and edge
• govt subsidies are 1 way to subsidize infrastructure & content, or can use pricing rule / regulation
• need a pricing rule to protect content creators and encourage investment
• will need to ensure fair returns for ISPs as part of regulation

H. Singer

• says that Livermore’s theories about Net Neutrality and investment are equivalent of “bunch of crap”!
• if you lower the expected return on an investment, you will see less investment

M. Livermore

• flips it, says we will see less investment from content providers with regulation of infrastructure providers

Susan Crawford

• what are the “harms”?

M. Livermore

• says harms deal with externalities and need to have regs to incentivize positive externalities

H. Singer

• fears of quality of service (QOS) prioritization are overblown

M. Livermore

• while some may benefit, problem with QOS is that some users are left less well off
• ISPs will set the price point incorrectly and harm other parties

H. Singer

• who is harmed?
• will carriers be forced to get permission to innovation

M. Livermore

• new entrants into marketplace will be harmed w/o regulation to ensure “open system”
• big boys will prioritize service and drive little guys away

H. Singer

• priority service is being mistakenly conflated with general access to networks
• we should strive for equality of opportunity, not outcome
• Net neutrality proponents keep creating new rationales for regulation, but no showing of harm

Markham Erickson – Open Internet Coalition

• The way the Net works now is relatively efficient
• Equate prioritization with a “tax” on providers
• don’t want to encourage ISPs to be getting returns though QOS efforts

Christopher Yoo – Univ. of Penn. Law School

• Big surprise with FCC Net Neutrality docket was how many comments were AGAINST regulation
• Most understood connection between regulation and investment
• NN debate often looks too much to the past
• Internet as we know it today (layered model) is fine, but network is evolving and flexibility is needed for new network applications (ex: multicasting, mobility, security, interactive video)
• Shouldn’t regulate to address ambiguous harms; will have unintended consequences
• wireless networks are particular problem since they operate differently; NN regs would hurt
• horror stories driving debate… remember AOL-Time Warner?  ended up being no big deal (Indeed!)

M. Erickson

• fears “slow lane” for most edge providers
• says ISPs will not re-invest “fast lane” money

C. Yoo

• raises First Amendment implications for Net Neutrality regulation
• some intermediaries will filter content to help focus people of best content; Is that allowed?

Audience Questions

• is there a third way that doesn’t “destroy the Internet?”
• what about negative externalities? (esp. congestion) (Livermore says change price structure for end users)

In a week in which neutrality regulation is making a lot of news, I hope that Robert Hahn and Hal Singer’s terrific new study, “Why the iPhone Won’t Last Forever and What the Government Should Do to Promote its Successor” gets some attention. It provides a wonderful overview of how dynamically competitive the mobile marketplace has been over the past two decades and why critics are wrong to get worked up about the short-term “dominance” of Apple’s iPhone. Here’s the abstract of their paper:

Because of the overwhelming, positive response to the iPhone as compared to other smart phones, exclusive agreements between handset makers and wireless carriers have come under increasing scrutiny by regulators and lawmakers. In this paper, we document the myriad revolutions that have occurred in the mobile handset market over the past twenty years. Although casual observers have often claimed that a particular innovation was here to stay, they commonly are proven wrong by unforeseen developments in this fast-changing marketplace. We argue that exclusive agreements can play an important role in helping to ensure that another must-have device will soon come along that will supplant the iPhone, and generate large benefits for consumers. These agreements, which encourage risk taking, increase choice, and frequently lower prices, should be applauded by the government. In contrast, government regulation that would require forced sharing of a successful break-through technology is likely to stifle innovation and hurt consumer welfare.

“New technologies often seemingly emerge from nowhere, but also frequently lose their luster quickly,” Hahn and Singer go on to argue. As evidence they cite the recent examples of Second Life and MySpace, which were hyped as potentially become dominant providers in their respective areas just a few years ago, but now are subjected to intense competition. “[T]he the mobile handset market is subject to these same disruptive forces,” they argue:

an iconic handset emerges, is quickly crowned the “winner,” and soon thereafter is replaced by another technology that was not even conceived of at the time the “winner” was launched. Many iPhone-inspired smartphones, including the Blackberry Storm and the HTC G1, could unseat the iPhone in the smartphone segment. We argue that heavy-handed regulation of such dynamic markets is likely to reduce welfare on net. The cost of erring through regulatory intervention—for example, by restricting voluntary private agreements that promote risk taking—can be significant. Delaying the benefits associated with innovation in mobile handsets could cost consumers dearly. In sum, exclusive contracts between handset makers and wireless carriers benefit consumers by encouraging innovation by both handset makers and wireless service providers that are vying for market share, and by enabling some handset makers to remain viable. These benefits take the form of greater variety of choices in handsets, greatly enhanced capabilities, and a more affordable range of device options. Banning exclusive contracts could have the unintended consequence of reducing innovation, reducing options, raising prices, and potentially establishing market dominance for an incumbent handset maker.

The End of Innovation?

In their excellent history of handset innovation over the past two decades, Hahn and Singer point out that there were many other “iconic” phones that some felt represented the end of the road in terms of innovation. I just love this quote they unearthed from a 1989 Fortune article about how the release of Motorola’s MicroTAC flip phone represented the apparent pinnacle of handset innovation: “Portable phones won’t get a lot smaller than this one. After all, they have to reach from your ear to your mouth.”

This highlights the myopia that sometimes accompanies technological forecasting and public policymaking.  We sometimes just can’t think “outside the box” and comprehend the ways in which technological devices or services might come along and leapfrog today’s market leaders. It gets back to the point I made in my recent book review of Gary Reback’s over-the-top ode to antitrust regulation, Free the Market:  Those who view markets through the lens of the a static competition, fixed-pie mentality always seem to live in fear of short term “market power” while those of us who believe in dynamic competition see markets in a constant state of flux and expect that sub-optimal market developments or configurations are exactly the spark that incentivizes new form of market entry, innovation, price competition, and so on.  And the real problem with that static competition mentality is that it often leads to knee-jerk regulatory responses.  Here’s how I put it in my recent debate with Larry Lessig:

What concerns me about the way Prof. Lessig approaches these issues in Code and in his subsequent work is that he is far too quick to declare the debate over by labeling short-term.. hiccups as sky-is-falling market failures. The end result of such myopic techno-pessimism is the inevitable call for governments to intervene and “do something” to correct supposed [market] failures.

In other words, have a little faith and some patience.  Apple’s iPhone is today’s hottest handset, but it’s hardly the end of innovation in this marketplace.  And we certainly don’t need handset regulation or “device neutrality” as a solution to this non-problem.  Read Hahn and Singer’s dynamite new paper for a better understanding of why that’s the case.

Several of us here have outlined our reservations about the proposal to allocate a block of the Advanced Wireless Services (AWS) spectrum for a free, nationwide wireless service. (Here’s a filing I signed on to that critiques the portion of the plan that requires censorship of the entire band once allocated).

But, strictly from an economic perspective, this is the best overview and critique of the plan I have seen so far: “The Static and Dynamic Inefficiency of Abandoning Unrestricted Auctions for Spectrum,” by Bob Hahn, Allan Ingraham, Greg Sidak, and Hal Singer. It’s a response to a paper favoring the M2Z plan that was penned by Simon Wilkie of USC, who also formerly served as the Chief Economist of the FCC. (Wilkie’s work on behalf of M2Z can be found on the M2Z site here). It’s a good debate and I encourage you to look at both papers if you are interested in this issue.