They said it wouldn’t happen. They offered assurances from three Wall Street analysts, who insisted that Internet service providers (ISPs) would continue to invest at the same levels regardless of the regulatory climate.
When it issued its Open Internet Order in February of this year, the Federal Communications Commission (FCC) never counted on its prediction being falsified before the U.S. Court of Appeals for the District of Columbia Circuit would rule on the legality of the agency’s net neutrality rules. But then came the second quarter S.E.C. filings of the largest ISPs. And the news was grim.
AT&T’s capital expenditure (capex) was down 29 percent in the first half of 2015 compared to the first half of 2014. Charter’s capex was down by the same percentage. Cablevision’s and Verizon’s capex were down ten and four percent, respectively.
This capital flight is remarkable considering there have been only two occasions in the history of the broadband industry when capex declined relative to the prior year: In 2001, after the dot.com meltdown, and in 2009, after the Great Recession. In every other year save 2015, broadband capex has climbed, as ISPs—like hamsters on a wheel—were forced to upgrade their networks to prevent customers from switching to rivals offering faster connections.
What changed in early 2015 besides the FCC’s Open Internet Order that can explain the ISP capex tumble? GDP grew in both the first and second quarters of 2015. Broadband capital intensity—defined as the ratio of ISP capex to revenues—decreased over the period, ruling out the possibility that falling revenues were to blame. Although cord cutting is on the rise, pay TV revenue is still growing, and the closest substitute to cable TV is broadband video. Absent compelling alternatives, the FCC’s Order is the best explanation for the capex meltdown.
Despite Comcast’s modest increase in capex in the first half of 2015—attributed to “customer premises equipment” to support its X1 entertainment operating system and other “cloud-based initiatives”—the net decrease across the six largest ISPs amounted to $3.3 billion in capital flight.
Why care about capital flight here? Every million-dollar increase in broadband capex in a given year generates almost 20 jobs through the multiplier effect. Chase a billion dollars in investment from the broadband ecosystem with heavy-handed regulation and you can wipe out 20,000 jobs. And if a billion dollars of withdrawn capital destroys 20,000 jobs, imagine what three billion . . . Shutter the thought.
In unrelated news, AT&T announced in June that it would invest $3 billion in Mexico to “extend mobile Internet to 100 million consumers and businesses” by 2018. It’s not as if investment dollars of the largest U.S. companies are fungible. Right?
Sadly, this capital flight was predictable. Reclassifying ISPs as public utilities under Title II of the Communications Act reduces the expected return of broadband investment. Although the ultimate purpose of Title II is to pry open the incumbents’ networks to resellers at regulated access rates, the FCC’s Open Internet Order promises to “forbear” from appropriating the ISPs’ property this way, at least as long as the political winds stay below a fresh gale.
Some analysts such as Anna-Maria Kovacs of Georgetown’s Center for Business and Public Policy tried to warn the FCC about the likely investment effects. Her submission was relegated to footnote 1229 on page 197 of the Order, while the FCC credited contrary (and demonstrably false) predictions of Philip Cusick (J.P. Morgan), Paul Gallant (Guggenheim), and Paul de Sa (Bernstein Research) in footnote 34 on page 13.
Economists fared no better. A seemingly relevant paper published in the prestigious Journal of Law and Economics in 2009 estimated that an increase in “regulatory intensity” in the European Union reduced “incumbents’ infrastructure stock by approximately 47 percent over the long term.” The FCC’s Order ignored that study altogether, as well as a rich economics literature with similar results.
Although the FCC’s Order failed to perform any cost-benefit analysis, a companion statement issued by the agency pursuant to the Congressional Review Act speculated that the Open Internet rules would generate $100 million in annual benefits for content providers. (I’ve assessed this casual empiricism here.)
Given the roughly $78 billion in ISP capex in 2014, Title II would need to scare off a mere 0.13 percent of ISP capex (equal to $101 million) to generate net losses for the economy. Based on the results from the first half of 2015, we’re heading for a capex decline nearly 100 times that level. Put differently, if just three percent of the observed $3.3 billion decline in ISP capex in the first half of 2015 can be attributed to Title II, the Order fails a cost-benefit test.
On December 4, some unfortunate FCC attorney will have to defend the Open Internet Order before a panel of judges on, among other things, cost-benefit grounds. With luck, a judge will ask about those assurances from the three Wall Street analysts.
This was cross posted from Forbes.