Desperate To Be Relevant, the FCC Pounces On the Internet

Spurred on by advocates of net neutrality, FCC Chairman Tom Wheeler has released a Notice of Proposed Rulemaking that has the potential to drastically reshape the Internet. While the possibility of a "fast lane" on the Internet has the proponents of net neutrality up in arms, the looming threat of regulation is far more troubling. The proposed rulemaking is exploring a number of options, including the possibility of reclassifying Internet Service Providers (ISPs) as a telecommunication service, which can then be regulated like the telephone system. Despite the lack of any evidence of market failure, Chairman Wheeler appears bent on expanding the FCC’s regulatory reach on the Internet.

Given the dynamism of the Internet economy, the legacy of rate regulation and natural monopolies is a poor reference point for future policy. Relying on old notions of regulated utilities can only impede competition and deployment of new technologies. Title II regulation was designed as a form of public utility regulation, where monopolists are allowed to operate under some form of price regulation while being allowed to recoup their capital investments and generate a "fair" rate of return for their investors. Much like state and federal regulators are arbiters of a fair return, Chairman Wheeler wants the FCC to determine what "commercially reasonable" pricing will be.

The history of economic regulation suggests that it is detrimental to both innovation and consumers. Regulatory oversight expanded from the start of the 20th century, as regulators assumed they could improve upon market outcomes. However, in the late 1970s, academic research and public policy practitioners demonstrated that competitive markets served consumers better than regulated markets. Many previously regulated industries-airlines, trucking, railroads, natural gas and to some extent telecommunications-have undergone the transformation to competitive markets. The general view among economists has been that economic regulation has served consumers poorly, and the potential welfare gains of deregulation can be significant. In all cases, competition provided lower prices and quality that equaled-if not improved upon-the existing industry standards. In one study, deregulation was found to provide consumers with benefits of at least $50 billion annually.

The newly proposed net neutrality regulations seek to allow the FCC to dictate to businesses how they offer service and what prices they can charge. This is clear in the FCC’s control over what is commercially reasonable. Efforts to redefine the Internet as a telecommunications service that would unleash Title II regulations would go further, turning the Internet into a regulated public utility. And unlike the cyberworld, the regulator’s world is not known for its lightning speed. The FCC’s call for an ombudsman to represent "consumers, start-ups and small businesses" is the first step down a regulatory rabbit hole of hearings, regulatory proceedings and other impediments to progress.

The nature of the Internet poses a serious challenge to FCC regulators attempting to determine commercially reasonable prices. Unlike most markets, the Internet is two-sided. Much like a newspaper provides a platform for both consumers and advertisers, the Internet provides a platform for consumers and content providers. In a two-sided market, the challenge is to set prices for both sides of the market. From the Internet provider’s perspective, this means establishing prices to optimize the overall value of the network for both content providers and consumers. The heavy hand of the FCC can make this problematic. Which of the two sides will be regulated? One net neutral solution would restrict prices on the content side, forcing consumers to pay for innovation through higher prices. All content would be treated the same, but does that warrant higher prices for consumers? Would it require a ratemaking process to answer this question?

With the old telephone system quickly moving towards antiquity, perhaps it is not surprising that the FCC has latched onto the Internet, a move of self-preservation that puts the agency at the helm of the most dynamic sector of the economy. Without evidence of market failure, this is sure to be more of a hindrance than a help. If the FCC wants to promote the Internet economy, it should focus on pushing scarce resources into the marketplace-such as spectrum auctions to expand mobile broadband-rather than replacing markets with a new regulatory regime.