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Review of Industrial Organization

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29-11-2016

Law, Social Welfare, and Net Neutrality

Author: Keith N. Hylton

Published in: Review of Industrial Organization | Issue 4/2017

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Abstract

Net neutrality generates wealth transfers from one type of internet content provider to another. In theory, these transfers might be socially desirable, and could be justified on the basis of informational externalities similar to those cited to justify fair use in copyright law. In practice, however, the conditions that justify fair use do not hold where net neutrality operates. Moreover, the internal subsidization required by net neutrality generates a regressive transfer. The welfare gains that might come from controlling anticompetitive abuse or government coercion through implementation of net neutrality can be achieved by alternative policies with less harmful consequences.

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As Becker et al. (2010, p. 498) explain, the net neutrality principle has devolved into four specific requirements: broadband providers are “prohibited from: (1) prioritizing traffic and charging differential prices based on the priority status; (2) imposing congestion-related charges; (3) adopting business models that offer exclusive content or that establish exclusive relationships with particular content providers; and (4) charging content providers to access the Internet based on factors other than the bandwidth supplied”.

On the variation in network services and costs, see Yoo (2013).

The similarity is that in both contexts, one observes large up-front capital expenses to construct a facility, and the incremental cost of using the facility is comparatively small. The economics of bridges is a topic with an extensive literature. See e.g., Hotelling (1938) and Minasian (1979). The difficult problem of optimal supply that was analyzed in the earlier literature has important implications for the treatment of different types of users, and the extent to which one can determine when the pricing of bridge services inefficiently advantages one user at the expense of another user. I will oversimplify and avoid most of these difficulties here.

I use the term cross-subsidy as an equivalent to “internal subsidy”, as in Posner (1971). This is a popular, though admittedly non-rigorous use of the term. In my treatment, a cross-subsidy or internal subsidy results from a regulation (such as a net neutrality requirement) when a firm is forced to change its pricing structure, as a result of the regulation, in a manner that benefits one group of consumers and disadvantages another group of consumers. The concept of cross-subsidy is difficult and would require a much more extensive treatment than is offered here to deal with adequately in economic terms. A rigorous treatment of the concept of cross-subsidy is provided in Faulhaber (1975).

Here I refer to the simplest form of Ramsey pricing that results from profit maximization by a multi-product monopolist. For simplicity, I assume that the user demand functions are independent of each other. For a straightforward presentation, see Tirole (1980).

See generally Baumol and Bradford (1970).

See Clark (2014).

See e.g., Becker et al. (2010) and Peitz and Schuett (2015). In my example in the text, if the privately-chosen prices are relatively close to the socially optimal Ramsey prices, then unregulated monopoly would enhance welfare relative to the equal-pricing rule.

Although the empirical importance of such depreciation may be entirely speculative, for a model that incorporates depreciation as a factor, see Odlyzko (1997).

Gordon (1982).

Rawls (1971).

See e.g., Posner (1981, p. 59). Of course, one could say that this is just an ordinary social welfare function that takes risk-aversion into account. See id.

http://civicscience.com/wp-content/uploads/2015/05/CivicScience-Netflixs-New-Users-May-2015-Final.pdf.

224 U.S. 383 (1912).

See e.g., Hazlett and Wright (2012).

On Ramsey pricing and broadband networks, see Yoo (2013, p. 580).

See Hazlett and Wright (2012, p. 782).

Most people have only one high-speed broadband provider; see http://consumerist.com/2014/12/18/govt-report-true-high-speed-broadband-competition-in-the-u-s-remains-largely-nonexistent/.

See Google Curbs Expansion of Fiber Optic Network, Cutting Jobs, New York Times, http://www.nytimes.com/2016/10/26/technology/google-curbs-expansion-of-fiber-optic-network-cutting-jobs.html?_r=0.

See http://consumerist.com/2015/10/29/shortlist-of-future-google-fiber-cities-keeps-getting-longer-three-more-cities-added/.

See Google Curbs Expansion of Fiber Optic Network, Cutting Jobs, New York Times, http://www.nytimes.com/2016/10/26/technology/google-curbs-expansion-of-fiber-optic-network-cutting-jobs.html?_r=0. Another new alternative is the use of small satellites to provide internet service: http://consumerist.com/2015/06/11/the-guy-who-started-tesla-wants-to-shoot-the-internet-to-you-from-space/.

MGM Studios, Inc. v. Grokster, Ltd., 545 U.S. 913 (2005); BMG Rights Management (US) LLC et al. v. Cox Enterprises Inc. et al., case number 1:14-cv-01611, in the U.S. District Court for the Eastern District of Virginia.

For example, on Comcast’s government business, see http://business.comcast.com/ethernet/industry-solutions/government.

Baumol, W. J., & Bradford, D. F. (1970). Optimal departures from marginal cost pricing. The American Economic Review, 60(3), 265–283.

Becker, G. S., Carlton, D. W., & Sider, H. S. (2010). Net neutrality and consumer welfare. Journal of Competition Law and Economics, 6(3), 497–519.CrossRef

Clark, D. (2014). Measuring Internet congestion: A preliminary report. https://ipp.mit.edu/sites/default/files/documents/Congestion-handout-final.pdf.

Economides, N., & Tåg, J. (2012). Net neutrality on the internet: A two-sided market analysis. Information Economics and Policy, 24(2), 91–104.CrossRef

Faulhaber, G. R. (1975). Cross-subsidization: Pricing in public enterprises. The American Economic Review, 65(5), 966–977.

Gordon, W. J. (1982). Fair use as market failure: A structural and economic analysis of the Betamax case and its predecessors. Columbia Law Review, 82(8), 1600–1657.CrossRef

Hazlett, T. W., & Wright, J. D. (2012). The law and economics of network neutrality. Indiana Law Review, 45(3), 767–840.

Hotelling, H. (1938). The general welfare in relation to problems of taxation and of railway and utility rates. Econometrica, 6(3), 242–269.CrossRef

Minasian, J. R. (1979). Indivisibility, decreasing cost, and excess capacity: The bridge. Journal of Law and Economics, 22(2), 385–397.CrossRef

Odlyzko, A. (1997). A modest proposal for preventing internet congestion. http://www.dtc.umn.edu/~odlyzko/doc/modest.proposal.pdf.

Peitz, M., & Schuett, F. (2015). Net neutrality and inflation of traffic. TILEC Discussion Paper No. 2015-006. Available at SSRN: http://ssrn.com/abstract=2573466 or http://dx.doi.org/10.2139/ssrn.2573466.

Posner, R. A. (1971). Taxation by regulation. The Bell Journal of Economics and Management Science, 2(1), 22–50.CrossRef

Posner, R. A. (1981). The economics of justice. Cambridge, MA: Harvard University Press.

Rawls, J. (1971). Theory of justice. Cambridge, MA: Belknap Press of Harvard University Press.

Tirole, J. (1980). The theory of industrial organization. Cambridge, MA: MIT Press.

Yoo, C. S. (2013). Is there a role for common carriage in an internet-based world? Houston Law Review, 51(2), 545–608.

Title: Law, Social Welfare, and Net Neutrality
Author: Keith N. Hylton
Publication date: 29-11-2016
Publisher: Springer US
Published in: Review of Industrial Organization / Issue 4/2017
Print ISSN: 0889-938X
Electronic ISSN: 1573-7160
DOI: https://doi.org/10.1007/s11151-016-9552-x

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Other articles of this Issue 4/2017

The Post-Internet Order Broadband Sector: Lessons from the Pre-Open Internet Order Experience

Introduction to the RIO Special Issue on Net Neutrality

The Effect of Regulation on Broadband Markets: Evaluating the Empirical Evidence in the FCC’s 2015 “Open Internet” Order

The Digital Divide and Other Economic Considerations for Network Neutrality

Some Simple Analytics of Vertically Linked Markets

The Evolution of “Competition”: Lessons for 21st Century Telecommunications Policy

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