Why Won't the FCC Just Let the Internet Be?

by: Craig Pirrong

For the past several years, there has been a debate raging over “net neutrality,” whereby the Federal Communications Commission (FCC) would regulate the terms of access to the networks of internet service providers (ISPs). In particular, the FCC’s original proposal on net neutrality (unveiled in October, 2009) would have prohibited ISPs from charging those supplying content, services, or applications different prices to access their networks. That is, net neutrality would have imposed a form of price control on the operators of networks. (Interestingly, the proposal would have permitted ISPs to charge downstream users different prices for different services.)

Several things about net neutrality raise alarm bells. The first is that anything that has an advertising-like, slogan-esque moniker that only a curmudgeon could take objection to is probably the product of a well-designed (not to say Orwellian) marketing campaign intended to advance a very specific interest. The association of major corporate interests, notably Google (NASDAQ:GOOG), with this endeavor only strengthens that suspicion.

The second, and more substantive concern is that price controls are almost always a very bad idea. Even if there is a colorable theoretical justification for a particular price control, its practical application by a government regulator subject to political pressure and interest influence is usually a disaster. And quite frequently, it works in a way that is diametrically opposed to the original intent (e.g,. the ICC regulation of railroad rates). Thus, a plausible economic case for an ideal price control implemented by an omniscient and benevolent regulator is a necessary, but not sufficient, condition to proceed with the imposition of a control by a flawed, human one–and the “F” in “FCC” could stand for Flawed (cf. Coase, 1959). (It could stand for other things, but I’m trying to keep this clean.)

In the case of the internet, there is not even a colorable case. One rationale is market power by ISPs. But a resounding majority of Americans have access to multiple broadband providers, including cable, DSL, and mobile broadband from several suppliers (e.g., Verizon (NYSE:VZ), ATT (NYSE:T), Sprint (NYSE:S)). Indeed, to the extent that there is a market power problem, it is the product of local grants of monopoly cable franchises. Nor is there any reliable empirical evidence that market power is a major problem in the market for internet access.

There are other speculative rationales for regulation, based on network effects, but the gap between theory and practice is so wide here that it would be outrageous to utilize a protean (though interesting) economic literature as the basis for a vast expansion of regulation. This literature can help conceptualize, but it is virtually useless as a guide to practical policy. “Died of a Theory” (h/t Jefferson Davis) would be a tragic epitaph for a vibrant internet.

Yes, I understand that network industries face a variety of competitive challenges. In fact, my next book is about network effects in financial markets and the regulatory and competitive conundrums they create. On a tangent: It’s always been a mystery to me why financial economists have largely ignored the similarities between financial markets and other network industries, and as a result have largely ignored the vast literature on other network industries and their regulation, especially telecoms and electricity transmission. One objective of the book is to redress that problem. One paper that will be the basis for a chapter in the book (from the JLEO, 2002) frames exchange regulation in terms of access to a network– exactly the same issue that is at the root of the net neutrality debate.

But since Nirvana is still just a band, the choice is not between an imperfect market and perfect regulation. The potential for regulatory mischief inherent in net neutrality is great. Indeed, the mom-and-apple-pie “non-discrimination” concept is anything but benign. (“Non-discrimination” is another one of those soothing, seemingly unobjectionable terms that is routinely used to camouflage some malign policy initiative.) In fact, efficient pricing requires pricing differentials when there are cost differentials–which almost certainly exist for different kinds of content delivered over the internet (e.g., bandwidth eating video content is far more costly than routine web page loading or email).

As Peltzman showed in his seminal 1975 paper on regulation, one motive for rent seeking manipulation is to suppress cost-based price differentials in order to benefit a politically powerful constituency. Given the names of the big supporters of NN, that seems exactly what’s going on here.

The FCC’s original neutrality NOPR came out when the Obama administration was still riding high and still drunk on its pretensions of intellectual superiority and political invincibility. Those now lie in tatters. As a result, a divided FCC, under the guidance of the execrable Chairman Julius Genachowski, has floated a scaled down version that eschews the objectionable price controls. This has dampened opposition from ISPs like Comcast and AT&T.

But watch out. As Tom Hazlett of George Mason University points out, there is Trojan malware lurking in the new proposal. Implicit in the proposed rule is the proposition that the FCC has the power to regulate the internet, a proposition that has been decisively rejected by the US Court of Appeals for the DC Circuit. This lot may beat tactical retreats, but they will relentlessly attempt to expand their powers when the opportunity arises in the future. Once FCC power over the internet is recognized and established in principle, it will be difficult to prevent it from being employed far more expansively–and destructively–in the future.

As a result, even this more benign version of internet regulation needs to be stopped. For all the (Orwellian) pro-competition, pro-innovation rhetoric emanating from people like Genachowski, and many predecessors at the FCC, the Commission’s effect on competition has been almost uniformly negative: it’s one of the poster children for the ironic quip: “I’m from the government and here to help you.” (Sadly, it’s just one of many: for this proposition, there are more poster candidates than Jerry’s Kids.) The internet has done just fine without the FCC, thank you. So it can continue to do just fine, the FCC should be kept out, today and forever more.

Disclosure: None