Net Neutrality Gambles On Grassroots Innovation

In February, the Federal Communications Commission (FCC) decided to subject Internet Service Providers (ISPs) like Comcast CMCSA +0.31% and Verizon to regulation under Title II of the Communications Act.
The FCC ’s net-neutrality plan will prevent ISPs from throttling or blocking Internet connections. But preventing monopolies from abusing consumers is only one part of the Title II juggernaut. Rate regulation is the other part. Under Title II, the FCC has authority to decide who pays for the Internet pipes down to the penny.
If the FCC begins setting the rates ISPs are allowed to charge, the economic consequences could be catastrophic. The FCC knows the risks of economic regulation all too well.
In 2004, Peyton Wynns, a senior economist at the FCC, explained why economic regulation fell out of favor in the latter half of the 20^th Century.

Over a long period of time, it became apparent that applying economic regulation was much more difficult than commonly supposed and the consequences were often unexpected. The regulatory process turned out to suppress innovation and productivity. The economic performance of regulated sectors was often worse than that of unregulated areas—even where the unregulated firms had some degree of market or monopoly power.

The FCC majority insists that net-neutrality’s embrace of Title II regulation will not lead to traditional rate regulation.
“Let me be clear, the FCC will not impose ‘utility style’ regulation,” said Tom Wheeler, the Chairman of the FCC, in a press release announcing the Title II decision. “That means no rate regulation, no filing of tariffs and no network unbundling.”
Not everyone believes the FCC will be able to abstain from regulating rates under Title II.

“Title II is about price regulation,” said Craig Moffet, a telecommunications analyst at Moffett Nathanson Research. “It would be naive to believe that the imposition of a regime that is fundamentally about price regulation, in an industry that the FCC has now repeatedly declared to be non-competitive, wouldn’t introduce risk to future pricing power.”

Network operators will not invest in new infrastructure if they cannot earn a reasonable return. If regulators set rates too low, investment dries up. That is exactly what happened to the railroads, as Robert Samuelson explained in a column for The Washington Post.

Samuelson argued that cost-allocation is the ultimate issue. In other words, who pays for the Internets pipes?
“Do big users such as Netflix NFLX -1.82% and Facebook bear some costs, or are these left to the ISPs — which shift them to the monthly bills of households?” said Samuelson. “If Netflix doesn’t pay its full costs, someone else will.”
The FCC majority is challenging the conventional meaning of rate regulation. For the past century, the prices people pay for goods and services have been set by government regulators or market forces. The FCC net neutrality strategy suggests that consumer-centric innovation can be used to regulate rates. The market and the government would be relegated to supporting roles.

This is the radical implication of the “virtual cycle” envisioned by the FCC majority, which claims that “innovations at the edges of the network enhance consumer demand, leading to expanded investments in broadband infrastructure that, in turn, spark new innovations at the edge.”
In this sense, net neutrality might be the biggest bet on bottom-up, consumer-driven innovation Uncle Sam has ever made.

Rather than rate regulation, robust demand for innovative services and products will ensure network operators have incentives to invest in new infrastructure. Customers will pay more for better internet service because they want new services and products. Apple AAPL +0.39%’s iPhones did not succeed because they cost less than other cell phones. The FCC majority is betting on the ability of American consumers to innovate in an open system.