^{Democracy & Technology Blog} Government thinks it can “preserve” Internet

Julius Genachowski, the new FCC chairman, announced that the commission will begin a rulemaking process to formalize and supplement existing network neutrality policy. According to Genachowski,

This is not about government regulation of the Internet. It’s about fair rules of the road for companies that control access to the Internet. We will do as much as we need to, and no more, to ensure that the Internet remains an unfettered platform for competition, creativity, and entrepreneurial activity.

Of course it is about regulation. The formal rulemaking process Genachowski is planning is for the avowed purpose of enshrining network neutrality principles in the Code of Federal Regulations.
Regulation always starts out small, before it grows really big. It has to: Loopholes and other unintended consequences (and opportunities) are always discovered after the “product” launches.
Genachowski unfairly and innaccurately implies that network neutrality opponents want to “abandon the underlying values fostered by an open network, [and] the important goal of setting rules of the road to protect the free and open Internet.” In fact, the existing Internet Policy Statement that would serve as the foundation of a new network neutrality regulatory regime received 2 Republican votes and 2 Democrat votes.
Genachowski is attempting to present a false choice between letting minimally trained politicians and myopic bureaucrats get their hands all over the Internet to remake it as they see fit versus “doing nothing.”

Saying nothing — and doing nothing — would impose its own form of unacceptable cost. It would deprive innovators and investors of confidence that the free and open Internet we depend upon today will still be here tomorrow. It would deny the benefits of predictable rules of the road to all players in the Internet ecosystem. And it would be a dangerous retreat from the core principle of openness — the freedom to innovate without permission — that has been a hallmark of the Internet since its inception, and has made it so stunningly successful as a platform for innovation, opportunity, and prosperity.

The current Internet Policy Statement already ensures:

(1) consumers are entitled to access the lawful Internet content of their choice;
(2) consumers are entitled to run applications and services of their choice, subject to the needs of law enforcement;
(3) consumers are entitled to connect their choice of legal devices that do not harm the network; and
(4) consumers are entitled to competition among network providers, application and service providers, and content providers.

Genachowski would add two additional requirements.
Discrimination
According to Genachowski,

The fifth principle is one of non-discrimination — stating that broadband providers cannot discriminate against particular Internet content or applications. This means they cannot block or degrade lawful traffic over their networks, or pick winners by favoring some content or applications over others in the connection to subscribers’ homes.

It’s already against the rules for broadband providers to block lawful content, and the FCC took enforcement action against one provider who discriminated against a particular application.
There may be some instances where it would be appropriate or desirable to favor certain content or applications in some way. Who knows? For example, some applications are highly sensitive to packet delay.
Discrimination is a pervasive and accepted commercial practice. Retailers choose which products to sell and how to present them to shoppers, for example. Manufacturers fight for shelf space.
Supermarkets have traditionally demanded “slotting fees” for their shelf space. Shelves are allocated according to who is willing to pay the most generous slotting fees. Manufacturers who want to position their products at eye level or at the end of an aisle pay the highest slotting fees.
No one would think to order a supermarket to build enough shelves to accommodate every product any manufacturer wants it to carry, ensure equally appealing placement for every product and be sure to charge each manufacturer the same price.
Yet this is exactly what network neutrality regulation would require of broadband providers.
Incidentally, Wal-Mart realized slotting fees are bad for sales. It concluded the fees reduced a retailer’s flexibility to stock and promote the most popular products; and lead to higher prices, because slotting fees are a type of marketing expense for manufacturers — the cost of which must be included in the price of the product. So Wal-Mart doesn’t charge slotting fees. This deliberate strategy places competitors who are reliant on slotting fees at a competitive disadvantage and under enormous pressure to conform.
Broadband services providers cannot profitably discriminate if they will lose sales to a competitor who offers better services, content and applications.
The best services, content and applications usually won’t be developed by broadband service providers internally. No one can think of everything.
The best strategy for broadband providers is to focus on their core competence and strive to build the best network. In order to carry the most traffic, they will want to carry the best services, content, and applications. That means welcoming independent service, content and application providers.
Transparency
According to Genachowski,

The sixth principle is a transparency principle — stating that providers of broadband Internet access must be transparent about their network management practices. Why does the FCC need to adopt this principle? The Internet evolved through open standards. It was conceived as a tool whose user manual would be free and available to all. But new network management practices and technologies challenge this original understanding. Today, broadband providers have the technical ability to change how the Internet works for millions of users — with profound consequences for those users and content, application, and service providers around the world.

There is always a danger public disclosure may also help cybercriminals and terrorists figure out how to defeat network management which protects consumer privacy, prevents online fraud or shields high-profile web servers from denial- or degradation-of-service attacks.
Genachowski says that a transparency principle would not require broadband providers to disclose information that might compromise the security of the network, but broadband providers may rely on the same network management tools for different purposes. For example, if a broadband provider discloses that it may use deep packet inspection to alleviate network congestion, that disclosure may provide useful clues regarding the provider’s capability to block malicious traffic.
It would be a shame if nondiscrimination and transparency were twisted into a de facto requirement for a standardized Internet, which would be the enemy of innovation.
If this sounds far-fetched, check out this paper by S. Derek Turner which is available at Free Press,

Currently, the Internet is an open platform, governed by a universally accepted and agreed-upon set of technical standards. This open platform provides online innovators with a high degree of predictability about a major segment of their business. An innovator knows that she can develop a new idea or application, and that it will work on any end-user’s Internet-connected device. The innovator does not need to go to every ISP and ask for “permission to innovate.”
But without Network Neutrality, this certainty is destroyed. A particular network provider might already have an exclusive deal with the innovator’s competitor — a deal stipulating that the ISP block or degrade all competitive traffic. Or the ISP may treat the innovator’s underlying network protocol differently than other ISPs, making it almost impossible to design an application that is guaranteed to work properly. This potential for discriminatory treatment and nonstandard network management could destroy investor confidence in the applications market, stifling growth in the one segment that drives the information economy. The Internet would become balkanized, whereby applications that work on one network would not work on another. The entire premise of a globally interconnected system of communications that is fully interoperable with all content and applications would be undermined. (emphasis added.)

“Limited competition among service providers”
Genachowski repeats the falsehood that the broadband market is insufficiently competitive. Over in Congress, the Markey-Eshoo bill says, “The overwhelming majority of residential consumers subscribe to Internet access service from 1 of only 2 wireline providers: the cable operator or the telephone company.” (See Sec. 2(9) on p. 3.)
The inference here is that a market consisting of only two providers is in need of government intervention. But it’s interesting to note that in the European Union, of all places, the official position is that wherever there is competition between at least two facilities-based broadband providers there is no market failure.
Of course, the U.S. broadband market is not a duopoly.
Approximately 92 percent of the U.S. population lives in census blocks with at least one provider delivering 3G mobile broadband service, according to the FCC.
The major wireless carriers are preparing to transition from 3G to 4G offerings, which promise much faster and more reliable mobile broadband service — and more formidable competition for the wireline telephone and cable providers of broadband.
The wireless market may not be perfect, as a hypothetical matter: Some clever person may be able to improve things.
However, the Supreme Court recently ruled that the nation’s leading antitrust statute does not “give judges carte blanche to insist that a monopolist alter its way of doing business whenever some other approach might yield greater competition.” Why should the Communications Act give eager politicians and bureaucrats carte blanche to dictate how broadband competitors do business whenever politicians and bureaucrats believe they can “help” somebody?
Innovation and investment
According to Genachowski,

Some will seek to invoke innovation and investment as reasons not to adopt open Internet rules. But history’s lesson is clear: Ensuring a robust and open Internet is the best thing we can do to promote investment and innovation.

According to the paper by S. Derek Turner at Free Press,

In network industries, regulations have only a minor influence over investment decisions. More important are considerations about future growth potential and fear of competition eroding profits. In fact, fear of potential regulations can actually encourage capital investment and counteract the most important factor discouraging investment — short-term shareholder concerns. This mistaken belief about the relationship between regulation and investment is not supported by evidence from the past decade — a period that saw the imposition of substantial regulation, followed by a period of equally substantial deregulation. During the years following the implementation of the 1996 Act, ILEC capital expenditures as a percentage of revenues rose dramatically. However, investment declined in the period following the FCC’s dismantling of this regulatory regime. (footnote omitted.)

Turner cites testimony of former FCC chief of staff Blair Levin (under President Clinton) to bolster his case. According to Levin,

[W]hile it is true that regulation, looked at in isolation, has a negative impact on investment in the enterprise being regulated, it may not be true when one looks at the whole picture….
For example, incumbent telecom capital expenditures as a percentage of revenues rose after the 1996 Telecom Act in a period when incumbents argued they were subject to significant new regulation, but after they won certain significant deregulation, the percentage declined. In both periods, the level of potential competition and the opportunity created by new investment was certainly a larger factor than regulation. 


Another example worth noting would be cable’s of capital expenditures. Looking at one piece of the puzzle, one could argue, with some validity, that the Cable Act of 1992 suppressed investment in the cable infrastructure. But looking at the whole puzzle one would see that part of that act, the program access rules, stimulated the rise of the Direct Broadcast Service industry, which in turn stimulated cable to invest in network upgrades to offer improved video service and an offering DBS could not offer: broadband. The rise of cable broadband, far more than any deregulation, was the principal cause of telco investment in network upgrades to offer DSL.

The telecom example is unpersuasive. Investment did increase in the immediate aftermath of the 1996 law because incumbent LECs mistakenly thought they would be allowed relatively rapid entry into the lucrative long distance market. It took a year or two for everyone to realize that the FCC had vastly different ideas.
Meanwhile, the favorable regulatory treatment the FCC bestowed on the new entrant competitive local exchange carriers contributed to a speculative bubble in telecom investment. When, in 2000, the telecom bubble burst and $2 trillion in private equity disappeared, everyone had to scale back their investment. The FCC’s pro-competition policy — however brilliant it appeared in theory — was a failure.
As for the cable example, Levin isn’t exactly looking at the whole picture. It is true cable companies had ownership interests in certain content and the program access rules ensured that this content could be available via their satellite competitors.
But the program access rules were merely an antidote for the harmful effects of previous regulation, which protected cable operators from competition — thus making it both easier and necessary for them to expand vertically. Examples of this regulation include exclusive franchises, the cable-telco crossownership prohibition and artificial spectrum scarcity.
The program access rules only prove that regulation begets more regulation.
In a recent post I discussed how innovation depends on market participants having the flexibility to pursue integration or modular strategies depending on whether existing products do not match consumer expectations for functionality and reliability versus whether product functionality and reliability exceeds consumer expectations.
Network neutrality regulation would kill integration and preserve modularity — not by prohibiting integration outright, just by ensuring broadband service providers reap none of the rewards and will face a regulatory minefield if they attempt to work individually with innovative content, device and application providers to maximize the user experience.
The bottom line is that network neutrality regulation will foster more regulatory predictability for independent content and application producers at the expense of other members of the Internet value chain, or “ecosystem” — broadband providers. That’s not the way to manage an ecosystem.
And it is ironic considering Genachowski is worried about “limited competition among service providers.” If that’s the concern, the solution is to promote private investment in broadband service. But Genachowski’s network neutrality proposal would divert investment from the core of the network to indpendent content and application vendors sitting on the edge.
Genachowski cannot plausibly claim his proposal will preserve a free and open Internet. By choking investment with new regulation, he will starve the patient.