More FCC Rules with Flawed Analyses Likely on the Way

In August 2015, I wrote a blog entitled “FCC’s ‘Gatekeeper’ Theory Is a Flawed Market Failure Analysis,” explaining how the FCC’s 2015 Open Internet Order fails a basic cost/benefit analysis and how it misuses data in order to support its claim that competition in the broadband market is lacking. Then, in January 2016, FSF President Randolph May and I wrote a blog entitled “Mobile Broadband Is a Substitute for Fixed Broadband,” where we state that the FCC continues to misrepresent competition in the broadband market by refusing to acknowledge the extent to which mobile broadband, for an increasing segment of the U.S. population, is a substitute for various fixed broadband services.

In a Hill article on January 20, 2016, Mario Trujillo reported that advocacy groups have been pressing the FCC to adopt Internet privacy rules. In a letter to the FCC, the advocacy groups say: “[Internet service providers’] position as Internet gatekeepers gives them a comprehensive view of consumer behavior and until now privacy protections for consumers using those services have been unclear.” The letter urges the FCC to “move forward as quickly as possible on a Notice of Proposed Rulemaking proposing strong rules to protect consumers from having their personal data collected and shared by their broadband provider without affirmative consent.”

The longer the Open Internet Order is in effect, the more people will realize that the regulatory costs imposed by the Order are stifling innovation and investment from both Internet service providers and edge providers. (See my October 2015 blog and Randolph May’s December 2015 blog for more on this.) However, there is reason to worry that if the FCC continues to misuse data to claim that “gatekeepers” eliminate choices for consumers, that switching costs create monopolies, and that mobile broadband should not be included in an analysis of broadband marketplace competition, then the FCC will be able to use these claims to justify adopting more Internet regulations.

Regardless of how Internet privacy rules would positively or negatively impact consumers, it should be concerning that the Commission could (and likely will) use misguided analysis to adopt such rules. In evaluating whether Internet privacy rules (and other regulations) benefit competition, consumers, and economic growth, it is imperative that they be supported by accurate data and valid cost/benefit analyses. But if the data and analysis used to inaccurately describe the broadband market during the Open Internet proceeding is used to draft Internet privacy rules, then the proceeding will start off on the wrong foot.

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.