Wednesday, August 19, 2015

FCC's "Gatekeeper" Theory Is a Flawed Market Failure Analysis

When analyzing the cost-effectiveness of a regulation, the first questions that should be asked are: Does the regulation address a market failure or systemic problem? If it does, how does it correct the perceived market failure? And do the benefits of the regulatory solution outweigh the costs of imposing new regulatory requirements? The Federal Communication Commission’s (FCC’s) February 2015 Open Internet order failed to properly address these questions.
On August 6, 2015, thirteen economists from prominent universities and policy institutes submitted an amicus brief to the D.C. Circuit Court of Appeals demonstrating that the FCC’s 2015 Open Internet order failed to include a basic cost-benefit analysis. One of the main arguments in the amicus brief is that the FCC employed an inaccurate assessment of market failure. The brief states that “the FCC had no basis for its finding that, absent Title II, Internet Service Providers will utilize ‘gatekeeper’ power to harm consumers and content providers.”
So how does the Commission attempt to justify the Open Internet order? It makes a number of assumptions about ISPs and consumer preferences but it fails to provide any evidence to back up these assumptions. The Commission claims that ISPs are monopolies. It argues that ISPs are “gatekeepers” who control the point of Internet access between content providers and consumers. The Commission says that this relationship encourages ISPs to harm consumers by discriminating against content providers who do not pay for priority.
In reality, ISPs have no incentive to block or throttle content when consumers have a choice between multiple providers. But the Commission creates a false narrative that so-called “switching costs” (or the time and/or money spent in order to switch from one provider to another) are too high, creating monopolistic market power even when multiple providers offer access in a given area. The order claims that “once a consumer chooses a broadband provider, that provider has a monopoly on access to the subscriber.”
The amicus brief responds with the following: “The same ‘monopoly’ could be said to exist for customers who have entered a movie theater or restaurant.” The amicus brief also explains that competition within a local market creates consumer choice and “compels ISPs to offer high quality services at attractive prices to prospective consumers in the hope they become actual customers.” For example, if one provider in an area requires early termination fees for a contract, competitors in the area would likely offer a lower priced service to offset those fees and attract consumers to switch.
The amicus brief gives the following example of how consumers respond to what they perceive is harm: “Time Warner Cable’s losses of broadband subscribers during its dispute with CBS in 2014, even when that dispute was over access to television content, is indicative of how strongly and rapidly consumers respond to changes in content availability.”
The Commission’s “gatekeeper” analysis is completely inconsistent. The Commission claims that the requirements of the Open Internet order, which supposedly prevent ISPs from acting as gatekeepers, are especially important for “rural areas or areas served by only one provider.” But then the Commission claims that areas with multiple providers are also essentially monopolies. The Commission also manipulates its broadband competition analysis by stating that “mobile broadband is not a full substitute for fixed broadband connections.” This despite the fact that 10 percent of Americans have a smartphone but do not have a fixed broadband subscription, according to the Pew Research Center. The fact that 10 percent of Americans made this switch means that the valuation of switching costs and the substitutability of broadband technologies are subjective to the individual consumer and should not be objective determinations by the Commission.
The Open Internet order uses Title II public utility style regulation, which was created for telephone monopolies, so I can see why the Commission – wrongly – attempted to justify its action by claiming that ISPs are monopolies. But because the Internet access market is dynamically competitive among multiple technologies, these regulations create costs which will crowd out innovation and investment. And the burdens of these regulations are likely to harm smaller competitors even more than larger, more-established ones.
So then how does the Open Internet order correct the perceived problems of gatekeepers, high switching costs, and alleged broadband monopolies? It doesn’t. In fact, the Open Internet order creates the exact problems that it is supposed to fix. The order creates an Internet access gatekeeper – the FCC – which must first approve ISPs’ (and likely content providers’) decisions to innovate, interconnect, and invest. It ultimately creates a higher market concentration due to higher regulatory costs pushing out competitors. And the order creates higher switching costs because, as competition decreases, consumers will have fewer choices.
The Commission’s attempt to create a market failure or systemic problem was inconsistent and its analysis was inaccurate. Unfortunately, it seems as if the decision to regulate the most dynamic market in the world came before any assessment of a market failure.