The Economics of Net Neutrality

First in an article series: MONEY YELLS!—Market Power and Corporate Control of Information.

By Rob Larson | July/August 2015

This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

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On February 26, 2015, the Federal Communications Commission (FCC) made a headline-dominating decision to regulate Internet providers through “net neutrality” principles, in a milestone for freedom of information and for popular activism. The Wall Street Journal reported that the decision was the outcome of opposing forces, both representing a “backlash.” The conservative paper had previously observed that if the agency moved forward with this regulatory stance, it would face a “Telecom Backlash” from Verizon, Comcast, AT&T, or their trade association, which had won court cases against the FCC’s earlier efforts to impose some net neutrality rules.

But the smashing victory was driven by another force that the Journal elsewhere called a “Public Backlash”—engaged people and activist groups who were often themselves unsatisfied by the FCC’s earlier positions. The FCC was swamped by the staggering volume of public comments filed—four million, with the press reporting that the “overwhelming majority of the comments supported common-carrier style rules,” the central requirement of net neutrality. The activist success in this backlash-off was importantly aided by the telecom industry’s own conflicting interests in the complex and rapidly evolving information marketplace, which created important opportunities for perceptive activists to exploit.

Not Neutering Net Neutrality

A Net Neutrality Glossary

  • Artificial scarcity: Most goods and services are necessarily “scarce,” meaning that the labor and resources required to make them are limited in supply relative to demand. Others could be abundant, meaning there could be enough to meet demand, but producers limit supply, making them “artificially scarce.” Many artificially scarce goods or services have negligible costs of production after development, for example drugs or software, but may be limited deliberately by an entity with market power, like the holder of a patent right.
  • Broadband: High-speed Internet access, via wired cable or fiber connection, a cell phone tower network, satellite service, or a local wireless hotspot.
  • Captured regulator: A government body created to regulate certain market practices in an industry, but which has become largely taken over by the industry itself, through lobbying or political action.
  • Common carrier: A provider of network services that obeys net neutrality rules, like the phone system under Title II classification.
  • Interconnection: The connections between networks, like those operated by ISPs and those operated by large content-providing firms, such as streaming video companies.
  • ISP: Internet service provider. Usually a private company (although a few embattled municipal networks exist) that runs a broadband network to consumers’ computers and phones, transmitting data from content providers like websites.
  • Market power: The ability of a market actor (or combination of them) to influence prices or market conditions.
  • Net neutrality: The principle that all data traveling through information networks to consumers should be treated equally. Practices that violate the principle include throttling of data to collect payment, discrimination among users or types of data, or paid promotion to ensure faster delivery.
  • Network effect: A service used in a network gains value as more users join. (If everyone you need to contact regularly has a telephone, telephone service is worth more to you than if they did not.) This feature tends to create market concentration and monopoly.

Net neutrality is the principle that data should be treated equally by network operators like Internet service providers (ISPs), the companies that transmit your online information packets through their cable or wireless services. This equality would rule out practices like an ISP blocking access to a website run by a competitor, or discrimination in service, where companies that can afford it get access to “fast lanes” that deliver their data more efficiently, while smaller sites that can’t cough up the money get relegated to the slow lanes.

A lack of net neutrality standards would have two broad consequences. One has to do with the prices paid for Internet access at reasonable speeds. The concern is that ISPs would create an “artificial scarcity” (see glossary sidebar) in information markets, allowing them to charge significant amounts to firms that can pay. Artificial scarcity describes to markets where production technology allows for an abundant supply, plenty to satisfy the consumption requirements for the whole market, but in which suppliers are able to restrict the amount produced. This often applies to markets characterized by intellectual property laws, like copyrights or patents, which limit lawful production to companies holding these licenses and thus possessing a monopoly. Profits are elevated with higher prices, but this cuts off some part of the market from consumption, making the product or service “artificially” scarce. For example, without net neutrality an ISP might charge streaming movie firms for faster service, leading those firms to raise their prices to a level that some consumers can’t afford.

The second point has less to do with relative prices and more to do with power. Having a degree of control over the flow of information through any medium, from phone service to TV to Internet access, grants a significant position of market power. The issue isn’t as abstract as it sounds. In 2014, without any regulation to prevent it, Comcast and other broadband providers deliberately “throttled”—restricted—the data transmission for the popular video-streaming service Netflix, frustrating thousands of subscribers waiting for their programs to load. To end the blockade, Netflix agreed to pay the broadband providers tens of millions of dollars a year. This was a significant trigger for elevated public awareness of neutrality principles, as the cable firms had gone too far—they had gotten between America and its TV shows. Likewise, Comcast was found to be blocking use of BitTorrent, including downloads of public domain content like the King James Bible.

These relatively innocuous cases show the powerful potential of a for-profit network. Broadband firms and ISPs could force content producers to contribute a major new revenue stream, while those unable to pay could be neglected or, indeed, actively throttled. The cable and wireless firms would thus have major leverage over the flow of information through society. The business media saw that these stories, plus the industry’s earlier court victories, “made clear that broadband access providers face few limitations on terms they can seek in negotiations with content companies.” Timothy Berners-Lee, considered to be the inventor of the World Wide Web, called this market development “a fundamental shift in power in the Internet economy,” driven by the growth of residential ISPs like Verizon and their buying up of other “backbone” network provider firms that used to deliver content. Crucially, this market concentration has made the ISPs into gatekeepers, a strong position since content lacks “any practical way to route around Verizon,” for example. So rather than the net-neutral view—all data coming through the pipe should be treated equally—the possibility arises that “in a world where Netflix and Yahoo connect directly to residential ISPs, every Internet company will have its own separate pipe.” Which would also make regulation far harder, all due to what Berners-Lee calls the “growing power of the residential broadband providers.”

Net neutrality activists argue that this potential power-mongering mess can be resolved through the FCC reclassifying the broadband providers under Title II of the Telecommunications Act of 1934. This is the regulation historically applied to “common carriers” relied on by the broader society, like the phone lines (see sidebar). It was an important triumph when the FCC voted along party lines to reclassify Internet service (and the activist tactics that led to this victory will be reviewed shortly). The FCC’s new rules conspicuously “forbear” to use the full regulatory apparatus of Title II, like price limits, keeping to a “light-touch” approach that leaves more freedom to the industry. But the main net neutrality provisions were confirmed, and the FCC in its rules frequently draws attention to the tsunami of public comments in justifying its decision: “Because the record overwhelmingly supports adopting rules and demonstrates that three specific practices invariably harm the open Internet—blocking, throttling, and paid prioritization—this order bans each of them, applying the same rules to both fixed and mobile broadband Internet access service.”

Title II

Title II of the 1934 Communications Act requires network-operating companies to treat communications equally and not discriminate among users or with respect to content. The classic example is telephone service, where Title II requires that if you call your doctor, for example, your call can’t be routed instead to another practice that paid the network operator. This means phone service is a “common carrier” of information, and the FCC’s reclassification of the ISPs as common carriers means net neutrality principles will be instated for cable and wireless broadband markets.

Part of the FCC’s calculation was the long- running trend in network-based industries to consolidate and create monopolies and oligopolies, one of the negative forms of what economists call “network effects.” This creates uniquely compelling incentives to grow and absorb competitors, leaving many US households with access to only one or two Internet providers. Communication scholar Tim Wu, coiner of the term “net neutrality,” observed in his excellent history The Master Switch that “over the long haul, competition in the information industries has been the exception, monopoly the rule.”

However, a good deal of uncertainty remains, including in significant areas like “interconnection,” the connections between different networks and content firms in the “guts” of the Internet. The FCC rules allow paid agreements for interconnection between the networks and content firms for faster, high-capacity connections, which had once been arranged on a bartered, two-way basis. These “premium” arrangements are allowed, but now may be individually challenged by firms case by case, with the FCC ruling on their legality on a so-far unspecified basis. The Commission has held that such agreements must be “fair and reasonable,” but has admitted that what will be allowed is unclear. However, even the ability to individually challenge this practice is relevant to net neutrality’s core principle of non-discrimination in the treatment of data. As Netflix spokespeople have commented “Had such a process existed when we were battling with the ISPs last year, we definitely would have used it.”

Bit Tyrants

The lineup of corporate forces on either side of the issue has attracted a good deal of attention. But with the information industry’s fast evolution, the lines have shifted quickly and need to be carefully analyzed. The most common picture puts the cable and wireless ISPs, primarily Comcast, Verizon, TimeWarner Cable and AT&T on one side—eager to charge for fast-lane access to their networks—with content firms like Google, Facebook and Yahoo on the other—hoping to go on expanding their businesses without new tolls for net access.

This basic antagonism has indeed applied for some time, including in the FCC’s previous attempts at net neutrality rules in 2010 (described below). It was reinforced by a 2014 open letter to the FCC—signed by dozens of tech firms, including titans like Google, Facebook, Amazon, Yahoo and Twitter—opposing Wheeler’s “paid prioritization” scheme, and arguing against allowing “individualized bargaining and discrimination.” The letter called the proposal “a grave threat to the Internet.” This stance was enormously significant as it put major corporate weight on opposing sides, a more common market development than is widely understood, affecting areas from health care to climate change.

However, the market and technologies have swiftly evolved, and when President Obama made his November 2014 video statement supporting Title II reclassification, the business press observed that the online giants left the response to the lower-profile Internet Association, their trade group. The National Journal’s interpretation was that “Aside from the letter, the big Web companies like Facebook and Google mostly stayed on the sidelines of the debate.” This “muted response” reflects the maturing of online markets and the growing market power of its largest firms.

Facebook, for example, is in a unique position to drive its millions of members to political action, but prefers to quietly position itself as an increasingly separate alternative to the Web. The eminent Tim Wu observes, “Many forms of content that once stood independent on the Web—personal pages, fan pages, e-vites, and so on—are now created instead on Facebook ... [U]nlike Web pages, Facebook pages are Facebook’s property, and are deliberately not linked to the rest of the Web.” To the alarm of neutrality supporters, this growing closed-off domain presumably encourages the company not to push too hard for the free and universal flow of information and Web traffic.

And Google itself is of unique importance due to its near-monopoly on search, a pivotal position that led Wu to call it the “Master Switch” of the whole Web, routing an enormous portion of internet traffic. Despite the company’s reliance on an open system for users to search, the firm has followed the universal incentive to exploit its network monopoly, increasingly steering users to Google-owned services, prohibiting websites that use its search results from using others’ (like Bing’s), and making it more expensive for advertisers to also run ads on other search engines.

For these reasons, the Federal Trade Commission (FTC) staff wanted to bring antitrust action against the firm, but in an unusual move the Commission disregarded its staff’s recommendations. In fact, the FTC concerns were only revealed when the information was accidentally released in the course of a Freedom of Information Act request. Unsurprisingly, Google had a “flurry” of meetings with administration figures as the FTC finished its investigation, and indeed now spends more on Washington lobbying than any other corporation, except Comcast.

Notably, Google is also moving toward becoming an ISP itself, with both its Google Fiber pilot projects in austin, Tex. and the Kansas City metro area, and its new phone service Google Fi. These developments mean the company is beginning to operate in both web traffic and web access, giving it conflicting allegiances in the debate. Indeed, after the Obama White House announced its support for common carrier rules, Google founder Eric Schmidt told an administration official that the position was a mistake. Even worse, in the proposed 2010 rule written by industry, Google agreed with Verizon that neutrality rules weren’t necessary on wireless systems! As a Wall Street Journal headline put it, “Google and Net Neutrality: It’s Complicated.”

Among the several neoliberal objections to the common carrier designation are the Republican FCC Commissioner Ajit Pai’s claim that the agency’s reclassification was unnecessary since “The Internet is not broken.” Those waiting impatiently in 2014 for Netflix to load when Comcast and other cable firms were throttling its data capacity might disagree. For their part, the cable and cellular ISPs claim that the threat of FCC interference will limit their infrastructure investments—meaning the networks will decrease their laying of cable and upgrading of network processes. But this claim is somewhat implausible in view of the staggering fact that the network giants make an absurd 97% profit margin on their bandwidth service, as MIT Technology Review reports. This cartoonish profit rate means that any mild regulatory burden is unlikely to overcome the enormous incentive to expand the business and swim in profit. Experience with net neutrality in Europe and elsewhere has borne this out.

Even the expected litigation against the FCC shows the industry’s disunity. The major trade associations, the United States Telecom Association and the National Cable & Telecommunications Association, filed their lawsuits immediately after the decision. But Comcast surprised observers by saying it will not itself sue to block the action (although this was before its gigantic merger with Time Warner Cable was rejected by the Federal Trade Commission). The situation remains in flux, but industry conditions may be somewhat suited for reconciliation with the new agency rule, as the industry is expected to continue its ongoing consolidation despite the Comcast-TWC setback. The numerous mergers pending government approval may promote accommodation.

Bet the Net

Since the role of nominally open-network corporations like Google turns out to be somewhat over-hyped, the changed position of the White House and thus the FCC must be credited to another factor, and it’s not too difficult to identify. The Commission received over four million comments on its proposed regulatory stance allowing “commercially reasonable” fast-lane treatment, with over 99% supporting strong net neutrality rules. The enormous volume of public comments repeatedly broke the FCC’s comment facility, but was only the most dramatic component of the overall activism strategy that resulted in the victory at the FCC. Having brought about a rare triumph against corporate power-mongering, these tactics are worth some attention.

One crucial dimension of organizing around the issue was the effective combination of online and offline organizing, especially relevant to an issue like this that directly impacts the web environment. So while activists in groups like Free Press and the Electronic Frontier Foundation publicized the issue and steered alarmed Web users toward the FCC comment system, others made plans to increase the heat on public officials through “real-life” actions. Most dramatically, activists camped out in front of the FCC building in Washington D.C., an “occupy” tactic that ballooned from a pair of activists in sleeping bags to a tent city of dozens of people. This move was important, especially since the direct action was prepared for with extensive education and awareness-raising. The valuable Waging Nonviolence activist website quotes Malkia Cyrial with the Center for Media Justice: “All along we’ve been doing a lot of education and advocacy, but at this point we’re ready to take direct action against these companies and target members of Congress.” Likewise Kevin Zeese, an activist with Popular Resistance, said, “We don’t like to occupy ... It’s a tactic that we use very sparingly.”

But the occupation—especially alarming to the FCC which is accustomed to bureaucratic invisibility—played a critical role, since reclassification of ISPs as Title II common carriers had previously been dismissed as “politically impossible.” As Zeese puts it, “But when they say it’s politically impossible, our job as activists is to make it politically doable.” Demonstrations spread to regional FCC offices and the corporate headquarters of Comcast and Verizon.

The Open Internet Order

In 2010, AT&T, Verizon, Google, and their lobbyist attorneys wrote a bill for the FCC, banning the net neutrality violations of blocking and discrimination among data transmission. But a gigantic omission pointed toward the reason for the phone corporations’ participation: The rule applied only to the “wired” Internet, meaning that part where service comes through a fiber or DSL line, not via a wireless signal. Wireless was and is the growth center of the industry, so this exemption meant AT&T and Verizon would be free to block, discriminate, and prioritize to their sleazy deal-making hearts’ content. Ultimately, this half-neutered set of FCC rules was struck down in court in 2014, setting the stage for Wheeler’s proposal for “commercially reasonable” prioritization, and the following deluge of public comments demanding neutrality.

The success of these activist tactics is especially impressive considering the FCC’s long-standing reputation as a “captured” regulator. The FCC’s chairman Tom Wheeler is himself a former cable industry lobbyist, and in 2010, the FCC’s first attempt at a neutrality policy was literally written by the industry, as has become the standard in many industries. This “Open Internet Order” totally exempted the wireless net and was struck down after a Verizon suit in 2014 (see sidebar).

Of course, the main venue for organizing actions remained online, fitting for the subject and also reflecting the shift of civic engagement to Web venues, for better or worse. In September 2014, many prominent Web companies staged an “Internet Slowdown,” replacing their normal home pages with a graphic of the ubiquitous spinning “loading” wheel, dramatizing the risks posed by fast- and slow-lanes to the flow of information. Participating firms included Web mid-weights like Mozilla, Kickstarter, WordPress, and of course Netflix. Notably absent were the heavyweights like Google, Facebook, or Apple, in line with their conflicting loyalties to the open net, outlined above.

Several of these tactics echo those used against previous attempts to restrain the open Web, like the copyright-mongering Stop Online Piracy Act in 2012, and the cable industry’s attempts to persuade Congress to strip the FCC of its authority to stop paid prioritization in 2006. In the latter case, one of the most impressive episodes of online social action, activists assembled an alliance of left-wing, right-wing, and overtly apolitical groups to oppose the measures, including the online majors, consumer groups, MoveOn.org, Free Press, SEIU, the Christian Coalition of America, Gun Owners of America, the AARP, the American Library Association, and National Religious Broadcasters. This hugely broad coalition opposed the attempt by the cable and phone corporations to put up toll gates to reach their enormous networks. This activism was effective enough to kill the bills in Congress, foreshadowing what may be required to keep Congress from overriding the FCC order in the future.

In the end, the huge battle for net neutrality, and the major victory of getting the FCC to grudgingly support it despite major industry resistance, is a surprisingly happy chapter in a long story. The triumph at the FCC will require future activism, from the creative activists who got us this far, to defend it in Congress and future administrations, as well as in court. The left doesn’t have a lot of triumphs to celebrate these days, so don’t let this one go by.

Four million commenters can’t be wrong!

teaches economics at Tacoma Community College and is author of Bleakonomics: A Heartwarming Introduction to Financial Catastrophe, the Jobs Crisis and Environmental Destruction (Pluto Press, 2013).

: Ryan Knutson and Thomas Gryta, “FCC Likely To Catch Telecom Backlash,” Wall Street Journal, Jan. 8 2015; Gautham Nagesh, “Net-Neutrality Proposal Faces Public Backlash,” Wall Street Journal, July 14, 2014; Rebecca Ruiz and Steve Lohr, “F.C.C. Approves Net Neutrality Rules, Classifying Broadband Internet Service as a Utility,” New York Times, Feb. 26 2015; Shalini Ramachandran, “Netflix to Pay Comcast for Smoother Streaming,” Wall Street Journal, Feb. 23, 2014; Timothy B. Lee, “Comcast’s deal with Netflix makes network neutrality obsolete,” Washington Post, Feb. 23, 2014; Candace Clementa and Matt Wood, “Why Title II Reclassification for Net Neutrality Is the Biggest Deal Ever,” Free Press, Feb. 4, 2015; Tim Wu, The Master Switch (Vintage, 2011); Drew Fitzgerald, “New Net Neutrality Rules Still Leave Some Questions Unanswered,” Wall Street Journal, Feb. 25, 2015; Drew Fitzgerald, “For Netflix, One Net Neutrality Issue Remains Unclear,” Wall Street Journal, Feb. 25, 2015; “Google, Facebook and Amazon write to FCC demanding true net neutrality,” The Guardian, May 7, 2014; Gautham Nagesh, “Amazon, Google, Facebook and Others Disagree With FCC Rules on Net Neutrality,” Wall Street Journal, May 7, 2014; Farhad Manjoo, “In Net Neutrality Push, Internet Giants on the Sidelines,” New York Times, Nov. 11, 2014; Brendan Sasso, “Despite fierce opposition from the major Internet providers, the FCC is poised to seize expansive new regulatory powers,” National Journal, Feb. 5, 2015; Rebecca Ruiz and Steve Lohr, “F.C.C. Approves Net Neutrality Rules, Classifying Broadband Internet Service as a Utility,” New York Times, Feb. 26, 2015; David Talbot, “When Will the Rest of Us Get Google Fiber?” MIT Technology Review, Feb. 4, 2013; Mark Scott, “Dutch Offer Preview of Net Neutrality,” New York Times, Feb. 26, 2015; Ryan Knutson and Thomas Gryta, “Telecom Industry Sues to Overturn Net Neutrality,” Wall Street Journal, April 13, 2015; Ben Collins, “Comcast Now Says It Will Not Sue FCC,” The Daily Beast, Feb. 26, 2015; Jay Cassano, “How activism won real net neutrality,” Waging Nonviolence, Feb. 26, 2015; Lawrence Lessig and Robert McChesney, “No Tolls on the Internet,” Washington Post, June 8, 2006; Jonathan Salant and Molly Peterson, “AT&T, Comcast Rout Google in ‘Net Neutrality’ Battle,” Bloomberg, July 20, 2006.

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