Quants have been studying the million-plus comments submitted to the FCC during the Open Internet proceeding, and unsurprisingly, the vast majority favor net neutrality. But what does that mean?
Those pressing for heavy-handed regulations would like it to mean “support for Title II,” but the myriad comments that mentioned Title II were most likely form letters generated by advocacy groups: It is doubtful that ordinary citizens understand the legal nuances that distinguish the FCC’s authority to regulate Internet service providers (ISPs) under section 706 and Title II.
To understand which regulatory path to take, we need to clearly define what sort of conduct cannot be tolerated on the Internet. Consider the following offer (“Offer A”) by an ISP to a content provider: “If you don’t take my priority-delivery offering, I will degrade your connection speeds on my network.” Such repugnant conduct would diminish the absolute performance of any content provider who declined the offer.
Now consider a slightly different offer by an ISP (“Offer B”): “If you don’t take my priority-delivery offering, you will continue to receive the same connection speeds that you previously enjoyed. If you take it, however, your connection will be even faster.” In contrast to Offer A, this offer would not threaten the absolute performance of the content provider; the only impact for those who decline it would be a diminution in their performance relative to those who elected priority delivery.
A broad consensus has formed around the need for regulation to prevent the type of conduct associated with Offer A. There is also wide acceptance of rules that would bar ISPs from favoring affiliated websites over independents by, for example, slowing or blocking access to the competing content. Importantly, none of these regulations would require the FCC to engage in rate regulation. All would be achievable under the “light-touch” approach of section 706.
What section 706 cannot prevent, however, is the type of conduct associated with Offer B. The D.C. Circuit has said as much, ruling that any attempt to prevent ISPs and content providers from negotiating for priority delivery smacks of common-carriage regulation. In other words, if rates for priority delivery were set by regulatory fiat, then there would be no need for ISPs and content providers to negotiate over the rate.
Title II would not bar priority-delivery offerings out of the gate: Even under Title II, ISPs would be free to offer such services, so long as they did so in a non-discriminatory way—that is, each package would have to be available to all similarly situated websites. But Title II could empower the FCC to begin a rate proceeding for priority delivery, at which point interested parties could petition the agency for zero rates, which would effectively eliminate priority delivery from the marketplace.
Would it be a good thing to unleash rate regulation on ISPs to prevent the formation of priority delivery? Not if investment is the metric. In a new study released by the Progressive Policy Institute (PPI), Bob Litan and I analyzed the impact of rate regulation pursuant to Title II on the investment of incumbent telcos, entrants, and cable providers in the 1990s and early 2000s. The results should give regulators pause before dabbling in rate regulation again.
Telco entrants: The 1996 Telecom Act required the incumbent Regional Bell Operating Companies—the localized telephone monopolies that were part of the integrated AT&T before it was broken up by court order in 1984—to share or “unbundle” the pieces of their local exchange networks to telco entrants at regulated rates to allow the latter to begin breaking down the local monopolies. With two co-authors (including your fearless blogger), Bob Crandall of Brookings used cross-state variation in the price of constructing local phone lines relative to leasing unbundled loops at regulated rates to identify the sensitivity of the entrants’ investment in local lines to these regulated rates. The researchers found that facilities investment by telco entrants was actually greater in states with higher unbundling rates; in other words, the more generous the subsidy, the less facilities-based investment occurred by telco entrants.
Cable companies: Cable television providers were best positioned to challenge the telcos’ hegemony in voice and Internet services in the mid-1990s. But to enter, cable operators first had to upgrade their networks to support IP-based transmissions. Yet cable companies were reluctant to make such investments so long as regulators were providing a less expensive entry path to their competitors (the telco entrants). High margins in local telephony and Internet access were the signal for cable entry, but the FCC’s unbundling experiment was injecting unnecessary noise. It took a series of court orders that unwound the unbundling regime by 1999 for the cable operators to see the market signal through the noise. Using data from NCTA, we found that the average annual capital expenditure for cable operators during the three years following the 1996 Act was $6 billion. In comparison, the cable industry’s average annual capital expenditure during the three-year period after the unbundling rules were unwound was $15.1 billion.
Incumbent telcos: Perhaps the most pivotal regulatory decision concerning the fate of broadband occurred in 2003. In its Triennial Review Order, which became effective in October 2003, the FCC determined that there would be no unbundling requirement for fiber-to-the-home loops. Once the telcos understood that they were free of the obligation to lease their fiber-based networks to competitors at regulated rates, they entered into a race with their cable counterparts to begin building the broadband networks that are now transforming the telecom landscape. In the span of just five years, from the FCC’s adoption of a policy of regulatory forbearance for fiber and IP networks in 2003, the miles of optical fiber doubled from five to ten million. Annual wireline broadband investment by the telcos jumped to $15.5 billion by 2008.
Why should the FCC focus on investment when promulgating new Internet regulations? First, Congress instructed the agency to do so in section 706 of the Act. Second, and perhaps even more important, investment in the communications sector continues to play a pivotal roll in driving the U.S. economy.
This week, PPI released its third annual report on “U.S. Investment Heroes,” authored by Diana Carew and Michael Mandel, which analyzes publicly available information to rank non-financial companies by their capital spending in the United States. Once again, AT&T and Verizon ranked first and second, respectively, with $21 and $15 billion in domestic investment in 2013. Comcast, Google, and Time Warner also made PPI’s top 25 list, each investing over $3 billion. The authors credit investment in the core of the network with sparking the rise of the “data-driven economy.”
In light of the results from prior experiments in rate regulation, the FCC should eschew calls to regulate ISPs under Title II. The incremental benefits (potentially barring fast lanes) are dubious, but the incremental costs (less investment at the core of the network) would be economically significant. Given its size and contribution to the U.S. economy in terms of jobs and productivity, even a small decline in core investment in response to rate regulation would impose social costs beyond the immediate harm to broadband consumers from an atrophying network.
Let’s not repeat the mistakes of the past. If we focus on what’s important—preventing an absolute decline in the welfare of content providers and preserving incentives to invest—we can nurture our precious Internet ecosystem at both the edge and the core.