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The Law and Economics of Network Neutrality

Profile image of Joshua WrightJoshua Wright

2011

Abstract

The Federal Communications Commission's Network Neutrality Order regulates how broadband networks explain their services to customers, mandates that subscribers be permitted to deploy whatever computers, mobile devices, or applications they like for use with the network access service they purchase, imposes a prohibition upon unreasonable discrimination in network management such that Internet Service Provider efforts to maintain service quality (e.g. mitigation congestion) or to price and package their services do not burden rival applications. This paper offers legal and economic critique of the new Network Neutrality policy and particularly the no blocking and no discrimination rules. While we argue the FCC's rules are likely to be declared beyond the scope of the agency's charter, we focus upon the economic impact of net neutrality regulations. It is beyond paradoxical that the FCC argues that it is imposing new regulations so as to preserve the Internet's current economic structure; that structure has developed in an unregulated environment where firms are free to experiment with business modelsand vertical integrationat will. We demonstrate that Network Neutrality goes far further than existing law, categorically prohibiting various forms of economic integration in a manner equivalent to antitrust's per se rule, properly reserved for conduct that is so likely to cause competitive harm that the marginal benefit of a fact-intensive analysis cannot be justified. Economic analysis demonstrates that Network Neutrality cannot be justified upon consumer welfare grounds. Further, the Commission's attempt to justify its new policy simply ignores compelling evidence that -open access‖ regulations have distorted broadband build-out in the United States, visibly reducing subscriber growth when imposed and visibly increasing subscriber growth when repealed. On the other, the FCC manages to cite just one studynot of the broadband marketto support its claims of widespread foreclosure threats. This empirical study, upon closer scrutiny than the Commission appears to have given it, actually shows no evidence of anticompetitive foreclosure. This fatal analytical flaw constitutes a smoking gun in the FCC's economic analysis of net neutrality.

Figures (12)
head to head with local phone companies. Veaicated Cable Danawiat for Cabie telepnony. ror years, U.o. regulators Grappied with the challenges presented in the local telephone market. Thought to be a natural monopoly at the time of the AT&T divestiture in 1984, the objective of gaining rivalry between competing services formed the basic motivation for the Telecommunications Act of 1996. While great efforts were expended in network sharing mandates, ultimately overtumed by federal courts as inimical to the stated objectives of the Act, success was finally had: local phone competition emerged when cable TV operators provided high-quality wireline voice services nationwide, haad tn haad with lacal nhnne cnamnaniec Fic. 1 U.S. CABLE TELEPHONE DEPLOY MENT, 2001-09! emerged when cable TV operators provided high-quality wireline voice services nationwide,
head to head with local phone companies. Veaicated Cable Danawiat for Cabie telepnony. ror years, U.o. regulators Grappied with the challenges presented in the local telephone market. Thought to be a natural monopoly at the time of the AT&T divestiture in 1984, the objective of gaining rivalry between competing services formed the basic motivation for the Telecommunications Act of 1996. While great efforts were expended in network sharing mandates, ultimately overtumed by federal courts as inimical to the stated objectives of the Act, success was finally had: local phone competition emerged when cable TV operators provided high-quality wireline voice services nationwide, haad tn haad with lacal nhnne cnamnaniec Fic. 1 U.S. CABLE TELEPHONE DEPLOY MENT, 2001-09! emerged when cable TV operators provided high-quality wireline voice services nationwide,
In 2005, just 27 percent of the twenty most profitable cable TV program networks wer owned by cable TV operators, weighted by (a) equity shares of ownership and (b) cash flows c the cable program networks.”’’ This represents a substantial decline in the level of vertic integration exhibited in earlier years. In 1992, for example, cable operators owned 41 percent ¢ the top twenty program networks, similarly weighted. The three most profitable network Nickelodeon, ESPN, and MTV) had no MSO ownership; seven of the ten most profitabl networks have no MSO ownership (eight out of ten, adjusting for the 50 percent MSO ownershi of Fox Sports and Discovery). It should be noted that even this ratio is largely due to MS¢ holdings in networks 11-20; in the top ten, MSOs accounted for just 19 percent of cash flows. FIG. 2 MSO OWNERSHIP SHARES OF TOP TWENTY CABLE NETWORKS, a _ _ CHIL
In 2005, just 27 percent of the twenty most profitable cable TV program networks wer owned by cable TV operators, weighted by (a) equity shares of ownership and (b) cash flows c the cable program networks.”’’ This represents a substantial decline in the level of vertic integration exhibited in earlier years. In 1992, for example, cable operators owned 41 percent ¢ the top twenty program networks, similarly weighted. The three most profitable network Nickelodeon, ESPN, and MTV) had no MSO ownership; seven of the ten most profitabl networks have no MSO ownership (eight out of ten, adjusting for the 50 percent MSO ownershi of Fox Sports and Discovery). It should be noted that even this ratio is largely due to MS¢ holdings in networks 11-20; in the top ten, MSOs accounted for just 19 percent of cash flows. FIG. 2 MSO OWNERSHIP SHARES OF TOP TWENTY CABLE NETWORKS, a _ _ CHIL
Fic. 3 DBS PENETRATION & VI NEUTRALITY: GOOLSBEE’S RESULTS check, helping to discern whether the coefficient estimates produced in the Goolsbee model are programming. But those results, however explained, do not imply vertical foreclosure. stable across alternative specifications that include theoretically important causative factors. In
Fic. 3 DBS PENETRATION & VI NEUTRALITY: GOOLSBEE’S RESULTS check, helping to discern whether the coefficient estimates produced in the Goolsbee model are programming. But those results, however explained, do not imply vertical foreclosure. stable across alternative specifications that include theoretically important causative factors. In
Fic. 4 DBS PENETRATION & VI NEUTRALITY: ADDING CHANNEL CAPACITY “4° A substantial number of observations are lost when Channel Capacity is included, reducing observations (each denoting a different cable TV system) from about 1400 to about 800, depending on the regression. Data unavailability already excludes the overwhelming share of cable TV systems from the analysis, however. Goolsbee’s regressions incorporate approximately 1400 observations from a universe that, in 2006, was comprised of 7,090 systems. See Industry Data, NAT’L CABLE & TELECOMM. ASS’N, http://www.ncta.com/ContentV iew.aspx?contentId=54 (last visited Aug. 7, 2011) (reporting Warren Communications data). 247 Can Bin A explanatory variable produces additional instability in results.
Fic. 4 DBS PENETRATION & VI NEUTRALITY: ADDING CHANNEL CAPACITY “4° A substantial number of observations are lost when Channel Capacity is included, reducing observations (each denoting a different cable TV system) from about 1400 to about 800, depending on the regression. Data unavailability already excludes the overwhelming share of cable TV systems from the analysis, however. Goolsbee’s regressions incorporate approximately 1400 observations from a universe that, in 2006, was comprised of 7,090 systems. See Industry Data, NAT’L CABLE & TELECOMM. ASS’N, http://www.ncta.com/ContentV iew.aspx?contentId=54 (last visited Aug. 7, 2011) (reporting Warren Communications data). 247 Can Bin A explanatory variable produces additional instability in results.
Fic.6. CM & DSL SUBSCRIBER GROWTH PRE- AND POST- DEREGULATION sharing, matched cable modem subscriber growth within just a few quarters. Exclusion: Raising Rivals’ Costs to Achieve Power Over Price, 96 YALE LJ. 215 (1986); Bruce Yandle, Bootleggers and Baptists-The Education of a Regulatory Economist, REGULATION, May/June 1983, at 12.
Fic.6. CM & DSL SUBSCRIBER GROWTH PRE- AND POST- DEREGULATION sharing, matched cable modem subscriber growth within just a few quarters. Exclusion: Raising Rivals’ Costs to Achieve Power Over Price, 96 YALE LJ. 215 (1986); Bruce Yandle, Bootleggers and Baptists-The Education of a Regulatory Economist, REGULATION, May/June 1983, at 12.
These data are consistent with the hypothesis that broadband network regulation is inversely related to deployment, and experts have asserted causality to the relationship. Fiber industry sales forecasts, for example, were projected by industry consultancy Gartner. Their initial forecast for 2004-08 was undertaken prior to the FCC deregulation. When the decision to bat unbundling obligations on new fiber networks was made, Gartner explicitly upped its sales estimates for fiber optic inputs.”
These data are consistent with the hypothesis that broadband network regulation is inversely related to deployment, and experts have asserted causality to the relationship. Fiber industry sales forecasts, for example, were projected by industry consultancy Gartner. Their initial forecast for 2004-08 was undertaken prior to the FCC deregulation. When the decision to bat unbundling obligations on new fiber networks was made, Gartner explicitly upped its sales estimates for fiber optic inputs.”
Fic. 8. GARTNER FIBER FORECASTS, 2004-0877
Fic. 8. GARTNER FIBER FORECASTS, 2004-0877

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