Why Not Net Neutrality?

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The case for regulation should rest on well established evidence, not specters of unseen horrors.

The FCC recently approved categorizing internet service providers (ISPs) under Title II of the FCC Telecommunications Act. Tom wheeler, the chair of the FCC board, has recently defended this action claiming it was not motivated politically. The FCC vote fell along party lines. The FCC board is required to have a bipartisan board. Of the 5, two must be from the opposing party, the Republicans voted against it, the Democrats for. This recent string of SEC regulations are a resurrection of a topic previously struck down in a case involving Verizon, just through a different avenue.

Despite all the information and misinformation I have found it difficult to discuss the matter openly and effectively. This is in large part a result of the breadth and complexity of this topic and how ambiguous the term “net neutrality” is. This latest move for a neutral net was largely sparked in a rant by the hilarious John Oliver, a man brave enough to criticize FIFA. After viewing his impassioned presentation I felt convinced this was a case for necessary rules preventing ISPs from throttling data and even potentially completely blocking access to certain websites. Most of this was built on the underlying presumption that ISPs, in particular Comcast, were monopolies and as such could act as a monopoly.

WHAT IS THE PROBLEM WITH MONOPOLIES?

Long have we worked to prevent natural monopolies from dominating markets. Intervention begins mostly in the last decade of the 19th century and early 20th century, most notably with the Sherman Act. The Sherman Act was designed to ensure a competitive market place and, later with the formation of the Federal Trade Commission (FTC), we have the basis for much of the antitrust (anti-monopoly) laws in the US. The major areas policed by antitrust law can be summed up as anything that appears to threaten the competition of a market place. This will not be a comprehensive history and analysis of antitrust law, but instead the general concept behind antitrust law and why it is enforced. Anti-competitive behavior includes price-fixing, dividing markets, rigging bids and unreasonable restraints on trade.

The Federal Communication Commission (FCC) originated in 1934 in an effort to regulate radio and wire communications. The FCC continues to monitor these forms and has now expanded to the internet. The limits of their authority are likely to be addressed in a separate piece outlining the overall regulations released by the FCC pertaining to internet companies. The FTC and FCC are different approaches to similar problems, that of monopolies.

Monopolies can arise naturally or artificially (granted by the state). A natural monopoly occurs when a market produces a single business or corporate entity that provides a good or service without any competition. In contrast, a monopoly may arise because of a legally granted right that prohibits or restricts competition in goods and services. Monopolies are economically problematic since they have very low incentives to invent and develop and charge a monopoly price for their goods and services compared to charging a price at or close to the marginal cost.

When the price of a good or service is above the marginal cost it creates what is called dead weight loss. The easiest way to understand dead weight loss is to consider what happens when an item is priced too high. Many potential consumers are priced out of market participation, and as result, would not receive the benefit of a service or good if it were priced closer to their valuation of a good. When a product is priced closer to the cost of producing the last profitable good (the value of a good declines as you produce more of it) it is said to be at or near the marginal cost or market equilibrium. Every item or good is different. Monopolies exclude potential consumers and since there is no continual battle for consumers, driving cost down, there is also less incentive to lower costs (be more efficient) and innovate. There is a lot of potential economic harm created by monopolies.

The question then would be, is this a monopoly and, if so, what is the solution? People often have misconceptions about monopolies and the potential harm they cause. One commonly held misperception is that a monopoly can do whatever it wants. Though this is much truer for a monopoly than in a competitive market, a monopoly still wants to make a profit and selling less of a good or service, beyond the monopoly price, will potentially cut into the profits of the monopoly. It is more accurate to say that a monopoly is less responsive to consumers rather than that they can get away with anything (though this tends to be truer when coupled with corruption and or public handouts, state granted monopolies tend to be the least responsive).

Another fallacy is that there is no competition unless a competitor sells the exact same good or service. This is simply not the case. Competition can come from substitute goods and services as well as similar goods. In the case of ISPs even if there is only one provider that sells at 50 mbs and then one at 15 mbs, this likely provides some competition even though the service is not exactly the same. The fact that there is only one high speed provider (though 15 mbs is more than sufficient to stream video) there are still two actors potentially pushing the market toward the marginal cost.

THE STORY OF NETFLIX AND “THE SHAKEDOWN”

To understand the story of Netflix and Comcast as featured in John Oliver’s video (if you haven’t watched at the provided link you are missing out – this man was trained by the master satirical newscaster John Stewart) a basic understanding of how the internet arrives at your house is necessary. Generally speaking when websites and internet meet magic is built and stored in a server, which is ultimately run to backbone networks and cross large distances. After the large distances are covered the internet is plugged into last mile providers, or Internet Service Providers (ISPs). This is your run-of-the mill Comcast, Time Warner, Cox style companies (though the list is extensive, those are some of the largest and most well-known).

Why does this matter? Context. Netflix is smart. They knew both a more effective and likely cheaper way to get their high demand content to their customers. They have set up shortcuts by cutting out the backbone providers and connecting directly to the ISP big boys. Backbone providers have, for a long time, arranged business negotiations between the ISPs and this largely occurs behind the scenes. When Netflix cut out the backbone providers they were in direct negotiations with the ISPs, including Comcast. Netflix wanted high speed delivery of its content but did not arrange for the contract well and under-bought the services. As CNET explained, “[b]ut as anyone who has streamed video knows, the amount of bandwidth that is needed to stream or download video far outweighs the amount of bandwidth needed to request such a video. And the result is a massive imbalance of traffic going onto the broadband network, which likely requires a commercial interconnection arrangement between Netflix and the various broadband network providers.”

Then it comes down to who should pay to upgrade the connection. It could be done “in one of two ways. Netflix could pay for a fire hose connection instead of taking the garden hose connection that it can get through a standard peering relationship with Comcast. The large connection would accommodate the Netflix traffic. The other option is to distribute its traffic more evenly among other CDNs that are delivering traffic to Comcast. In this case, the video traffic could get onto the Comcast network via the many garden hoses already connected to the Comcast network.” This was bound to cost Netflix more money, though in the long run by cutting out backbone providers they likely saved  a lot of money.

Either way, this appears to be a normal business deal and for a further breakdown of what occurred (the deal has long been settled) read the provided hyperlink. Many I talk to claim this was a shakedown, and so did John Oliver, but in reality it looks as if it was paying to connect to the ISPs and was a normal contract negotiation. The evidence of it being price discrimination (a shakedown) by a monopoly against a little guy is rather slim. The slower speeds appear to be caused by switching the way business is done between content providers and ISPs and covering the costs effectively to set this up.

THE POINT THAT A BIT IS A BIT

A bit is a bit, unless it is something slightly different. Net neutrality is largely focused on treating data the same from all content providers. This is the big scare, and a large part of why the John Oliver bit was so frightening to many. On the face it appeared as if there was content discrimination by an ISP to get more money. This looked terrible. It also seemed rather tyrannical. A fear of oppressive monopolies rose to the minds of many, even outright censorship was being listed as the possible horrors inflicted by monopolistic corporations. The idea that it was wrong to discriminate how fast, slow or even if you could receive the information based on point of origin was flat out terrifying to many. After all data is data and a bit is a bit. That is, until it is not.

The reality is there are good reasons to treat data differently based on what type of content it is. When the data is passed through from the providers to backbones to ISPs, it is broken into packets that are delivered and arranged to display amazing internet information. Take email for example. It is sent to your browser in packets that are opened up to build your new message from your favorite long lost Prince of Nigerian Uncle who passed away and picked you to be the beneficiary of his massive estate. For this email, it does not matter how the packets arrive. They can arrive in order or not, and they can arrive even spaced in time and when they do arrive your very smart computer/browser/phone puts it together so you can read it. Video is not quite the same. It needs to arrive sequentially and in close temporal proximity. When this doesn’t happen, it buffers. It is also a lot more data than a simple email. However, that being said, even if it were the same size as an email, since the way video is delivered matters, it is more demanding.

To argue that a bit is a bit is technically true, but to assert there is no valid reason to discriminate, to charge a video carrier more than an email provider, or a news organization, or whatever it may be, is not exactly true. The fact that ISPs recognize this, in the long run, is likely a market benefit. As a consumer of data I don’t want it treated the same. I want video to be given priority. It is more demanding and there is likely ample justification to treat it differently. It isn’t just data you are paying for but the delivery of data. If the bit is wheat then the delivery is either the train, airplane, truck or teleporter you use to get that wheat. It changes the cost of the wheat you consume even if the wheat in location A is exactly the same as wheat in location B. Getting it to point C may differ. Part of the reason Netflix bypassed the backbone providers (besides to make more money) is so the data could be delivered more effectively. Saying that all data should be treated equally ignores that different data, though all are bits technically, must be delivered according to the demands of the product. Since the conception of net neutrality a metaphor of a highway was used to describe the fast lanes and slow lanes of data delivery, however this is a an inapt metaphor upon scrutiny since we actually benefit from better delivery for high demand products.

BACK TO MONOPOLIES AND A COMPARISON TO NET NEUTRAL COUNTRIES

Internet regulation may be justified if there is evidence that it is dominated by a monopoly, however the fact that you individually may only have access to a single ISP isn’t evidence that it is in fact a monopoly (though I highly doubt that is the case).

What evidence is there that monopoly conditions exist in the United States for the internet? Many use anecdotal evidence, saying the only high speed provider available is, usually, Comcast. Though there are several others such as Time Warner (though perhaps problematically merging with Comcast), Cox, and Verizon. All of which offer high speed cable internet and tend to hold dominant market shares in their respective regions. However, approximately 33% of the internet market has access to only one land-based ISP, not counting phone services. In other words 66% of the US market has access to at least two ISPs. On top of that 82% of users in the United States have access to speeds of 25 mbs or more compared to only 54% in European countries that have enacted similar utility restrictions (some form of net neutrality).  This suggest that not only is there not a monopoly problem but that those places with restriction are worse off than the United States.

Further evidence that there is not a monopoly is the per household investment in internet. In the United States annual internet investment is approximately $562 per household, this is money the providers are putting down. In European countries with net neutrality regulations, it’s only $244. Other metrics for comparison are equal or better ISPs than utility regulated countries. There is even evidence that per bit cost is going down over the long term. However, price per bit is not always the best measure even though it is a downward trend since the price declines until there is a need to install new base stations.

On top of all of this, when people who don’t use the internet are asked why, the number one answer is “just not interested.” So despite the fact that some aren’t engaged in the market, the number one reason is simply that it isn’t important to them. This is different than the harm of dead weight loss, which would indicate the opposite – that many want to engage and are priced out of participation. Despite the outcry, there is insufficient evidence to claim there is a substantial amount of harm, or really evidence of any harm, in the market overall. This is not to say that some geographic areas are not subjected to a monopoly, even though the internet is changing frequently, take cell phone data which is now able to stream movies, TV shows, and even live sports. In theory this would make cell providers competitors against land based internet providers. Increasing access to the internet over a different medium, for example phone versus landline, is much more likely a point against net neutrality AND the regulations will apply to phone providers, which doesn’t bode well for the industry.

In the end, it appears that not only is there little evidenced that ISPs get away with monopoly behavior, but that places with internet regulation provide poorer services (I know this is hard to believe for the average Comcast customer, and I’m sympathetic) and invest less into the industry.

THE POTENTIAL HARM OF REGULATION

Phone companies long labored under the common carrier provisions instituted under Title II of the telecommunications act. Some extol the virtues of the past regulations, but it was not without problems, and it certainly created inefficiencies. One of the major and most worrisome problems is the reality that it turns likely short-lived monopolies into semi-permanent fixtures. In the long run this is certainly in the best interest of those already with control of the market since they will maintain their control for longer and avoid the creative destruction that has visited the internet industry since inception.

One of the likely problems with net neutrality- which is, once again, the concept that there should be no discrimination on the basis of content provider- is that it may distribute costs unevenly. As discussed before there is likely a very good reason to discriminate since video is much more demanding than other uses; even if the amount of data (bits) is equal. That means that the more demanding delivery is likely to be distributed among other users in terms of cost. In short, a high end user like Netflix is likely going to be able to pay less for the type of content provided and push that costs onto other, less-demanding, content providers.

Another potential problem was voiced by Mark Cuban, who pointed out that data is data, and TV and cable providers currently use data to transmit television signals. Without the ability to discriminate there may be buffering where we rarely experience it. Whether or not this happens is largely speculation, but it is a possibility. The reality is the control of the internet is now subject to a whole slew of potential problems that were never before experienced in the history of the internet. In reality, we have taken something that has been working rather well and subjected it to control by a central authority. The censorship and slowdowns lamented have never occurred on any widespread basis. Fewer than ten times have companies tried to slow it down or cut off access and it has never worked out in favor of ISPs. Fewer than 10 times over many years of internet innovation. Thus, net neutrality is largely a prophylactic measure, to prevent a non-occurring, never before successful, potential harm.

One of the last problems with regulation generally, and this is no exception, is that regulation has a similar impact as tax. It imposes a cost that is not natural to the production of the good or service. In short it creates dead weight loss, since it raises the price above that of the marginal price. The question is then: Does the regulation create more dead weight loss or economic harm than a monopoly? At this moment there is little evidence to show that this kind of overarching market interference is necessary. Even if a monopoly exists in some places there are likely better solutions. Especially since there is no evidence that the ISPs are actually acting as monopolies in the whole. Instead they are likely localized which requires a different remedy. One such remedy is involvement in local municipalities, especially since cities are generally the driving force in granting monopolies where they do exist. Local involvement is more likely going to dissolve monopolies than any regulation.

The final point is simply that when in doubt, a presumption of liberty, free markets,  or government non-intervention is the best default stance. Government intervention leads to rent seeking and inefficient behaviors. Some may contend this market is already tainted by the influence of local governments granting monopolies to Comcast and other ISPs. This is a valid contention but one that simply should not be addressed with federal intervention, instead the remedy is local involvement. Particularly since the monopoly power is not universal, but instead is localized. Without compelling evidence the case for net neutrality is largely unconvincing.

James C. Devereaux is an attorney and freedom fanatic. Questions, complaints and hysterics can be sent to james@reasonedliberty.com

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