The Economics of the Net Neutrality Repeal

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The December 14th vote to repeal the current net neutrality rules established in the 2015 Open Internet Order has inspired an uproar from many in Washington and the media. The movement to preserve net neutrality is enticing, sure, but, beyond the babble of civil liberty, there is a strong case for repeal that is entirely based on the economics of such regulation. The debate over this issue should have been more economically focused anyway, as the most major potential consequences of net neutrality have far less to do with whether or not our internet will be able to load episodes of The Office on Netflix at prompt speeds and far more to do with whether or not our internet will be in a condition to function at all.  

At a close look, the passage of the FCC’s proposal to repeal net neutrality does have strong economic backing and the arguments in favor of net neutrality repeal are listed here:

The issue of Internet Service Provider (ISP) malpractice is potentially solved by FTC oversight and transparency policy anyway, per the Restoring Internet Freedom order.

No, the FCC’s intentions are not to return the internet to being a regulation-free frenzy where large, corporate ISPs can freely dish abusive treatment towards content service providers (CSPs) that they dislike. In fact, the FCC’s new proposal actually addresses the issue of ISP malpractice by passing oversight responsibilities onto the Federal Trade Commission, which is already well-versed in ensuring fair business practices under existing antitrust and consumer protection laws. As stated in the order itself,  the FCC’s approach “restores the authority of the nation’s most experienced cop on the privacy beat—the Federal Trade Commission—to police the privacy practices of Internet Service Providers (ISPs).”

The Restoring Internet Freedom order also adopts a set of standards for ISP transparency, under which ISPs would have to disclose information about their practices to consumers and regulators with the hope of enhancing the competitive process. The idea is that with such knowledge, regulators would be able to easily monitor ISPs’ behaviors, and consumers would be better able to decide which particular ISP fits their individual needs.

Current net neutrality regulation sets a ban on discriminant pricing practices, acting as a price control that distorts allocation of resources.

The 2015 Open Internet Order outlined three bright-line rules for ISPs to follow – its standard for ISP conduct.

The most economically significant is a prohibition of “paid prioritization,” means that ISPs can not discriminately charge different CSPs for their services under any circumstance, and must instead price all CSPs uniformly. It is, in effect, a ban on discriminant and differential pricing, practices where one company sells a product to different buyers at different prices based on individual willingness-to-pay, whether it be for the same quality product (discrimination) or for differing qualities (differentiation). Since this rule forces an ISP to charge CSPs prices for its services that are not analogous to the true value of the service, it acts as a special-case price control.

As nearly all mandated price controls do, this conduct rule creates inimical inefficiencies in the ISP market. The uniform pricing of CSP’s means that ISP’s must price its services without regard for the amount of bandwidth any particular CSP will use up. For example, even though a CSP like Netflix, with its video streaming services, will operate enormous portions of an ISP’s available bandwidth, it cannot be charged differently than a CSP that uses significantly less bandwidth. Ultimately, the price Netflix is charged will be much lower than the actual value of the service it’s receiving, the market price of the service, creating a shortage in the market as a result. A shortage is just the most major of several possible distortions in allocation caused by the pricing rule, all of which could potentially create volatility in the ISP market.

Capital investment in broadband infrastructure will decrease if ISP market becomes more volatile.

Due to the adverse circumstances created by hindering regulation like the “paid prioritization” pricing rule, participation in the ISP market has become increasingly unfavorable. If a company operates in an anti-business climate, capital investment in that company will obviously decrease. In the same sense, because of these adverse circumstances for ISPs, investment in broadband infrastructure, which is necessary for ISPs to improve their methods of content delivery, could take a serious tumble. Evidently, it already has.

According to a research report by USTelecom, broadband infrastructure investment dropped nearly $2 billion from 2015-2016 following the 2015 passage of the Open Internet Order. This was the first major dip in broadband infrastructure investment since the Recession, and a continuation of this trend could have serious consequences– to be explained later on.

A ban on price discrimination and differentiation could lead to an increase in the cost paid by consumers over time.

ISPs operate in a unique type of market, known as a “two-sided market,” which can be thought of as a meeting place between two, separate, mutually benefitting user groups. ISP services involve the delivery of content, put out by content service providers (CSP’s), to its base of subscribers. It must first sell its services to CSP’s, who desire for their content to be accessible to as many users as possible, and then sell its services to internet subscribers, who desire access to CSP content at an amount and variety that suits them in particular– ergo, a two-sided market.

There exists a principle in economics, known as the “seesaw principle,” which, when applied to two-sided markets, implies that downwards pressure on price on one side of the market tends to have an opposite, inverse effect on the other side, causing upward pressure on price. Essentially, a high price on one side should induce a low price on the other, and vice versa, reflecting the motion of a seesaw. In regards to net neutrality, because the “paid prioritization” rule forces relatively low prices to be charged to CSPs, the probable effect would be an increase in prices charged to internet users over time.

The ultimate worst-case scenario: If broadband infrastructure is insufficient in handling future levels of internet traffic, serious congestion problems may arise.

As explained before, investment in broadband infrastructure is likely to continue to decrease if ISPs are unable to specifically price CSPs. This would mean that ISPs would be increasingly unable to maintain, improve, or expand their networks. Simultaneously, internet traffic is expected to become more crowded in the near future with the continuing rise in mobile device usage. As demonstrated in a projection published by Statistica, the total number of internet users in the US is expected to increase steadily, potentially reaching 283.51 million users in 2022.

Eventually, we could reach a point where internet traffic is too great for existing broadband technology to handle, causing serious congestion problems for ISPs. Consequently, internet users’ access to online content could become increasingly slowed, raising the exact problem that net neutrality advocates feared in the first place. Except here, the issue is outside of the motives of ISPs, and is ironically caused by net neutrality. In fact, most of the cases of ISP malpractice that started the discussion of net neutrality originally, were caused by ISPs having to deal with congestion problems.

Would the continued abidance by the 2015 net neutrality rules spell the death of the internet itself? Well, almost certainly no, but they could potentially have serious negative effects on the internet’s reliability in the near future.

The views expressed in this article are the opinion of the author and do not necessarily reflect those of Lone Conservative staff.

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