Takeaway: Net neutrality critics are celebrating the repeal of key Internet regulations, but the battle is not over—indeed, it may have just begun.

MARKET WATCH: What’s Happening? Last month, the FCC voted to repeal key regulations that defined broadband Internet as a utility and imposed common carrier regulations on Internet service providers (ISPs). Net neutrality supporters complain that ISPs, without regulation, are destined to abuse their monopolistic pricing power and arbitrarily control the flow of information. Critics contend that net neutrality regulation would damage the Internet by stifling ISP investment and innovation.

Our Take: The debate has been miscast. Unless the ISP industry can be made more competitive, the question that must arise, sooner or later, is not whether to regulate ISPs but how to regulate them. The FCC decision to repeal net neutrality could be overturned on technical grounds. And if this doesn’t happen soon, Internet freedom is likely to become a political rallying cry—probably for a Democratic Party eager to bill itself as protecting the consumer and doing battle with ISP tycoons. Whatever happens next, the terms of the net neutrality debate in 2018, 2020, and beyond could help redefine the American political landscape.

In December, the Federal Communications Commission (FCC) voted three to two in favor of dismantling Obama-era regulations designed to protect net neutrality. The ruling was a huge blow to companies, advocacy groups, and consumers who fear that ISPs will use their newfound freedom to discriminate against certain types of Internet traffic. Proponents of the repeal, on the other hand, claim that ISPs unencumbered by common carrier regulations will now be able to step up their investment in the U.S. broadband infrastructure and better serve consumers.

The debate over net neutrality remains a wonkish subject seemingly of interest only to tech geeks. But weaved into the backdrop of the debate are some fundamental political choices about how to regulate information in a democratic society and how to balance the interests of consumers versus producers in uncompetitive markets.

Let’s investigate.

THE FCC BACK AND FORTH

The FCC’s recent net neutrality vote is the culmination of a years-long saga. The first chapter began in 2004, when then-FCC Chairman Michael Powell (appointed as chairman by President G.W. Bush) drew up his principles of “network freedom” designed to protect Internet users from unfair or discriminatory practices, which represented the first formalized version of what is today considered net neutrality.

The following year, in 2005, these principles were tested when Comcast began covertly limiting access to P2P sites like BitTorrent. But upon attempting to prosecute Comcast, the FCC ran into trouble. At the time, Comcast and other ISPs were governed by the Title I “information service” provisions of the Communications Act of 1934 as amended (which relegates any antitrust enforcement to the FTC) rather than the Title II “telecommunications service” provisions of the act (which include price and entry regulation by the FCC). Thus, the FCC’s case was shot down by the D.C. Court of Appeals—which concluded that the agency did not have the regulatory authority to enforce net neutrality on ISPs.

The agency’s solution? Place ISPs under Title II jurisdiction. Under Obama-appointed chairman Tom Wheeler, the FCC released its landmark 2015 Open Internet Order, which for the first time designated broadband Internet service as a Title II public utility, like electricity or natural gas. The order also imposed “common carrier” regulations upon ISPs—prohibiting them from blocking certain content, “throttling” certain customers (intentionally limiting their bandwidth), or practicing “paid prioritization” (letting content companies pay to “cut in line” during times of broadband congestion).

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The latest twist came when, in one of his first moves upon assuming office, President Trump elevated Ajit Pai to FCC chairman in early 2017. A net neutrality critic, Pai had voted against the 2015 order, and said once he was handpicked as chairman that he would revisit the Title II classification “as soon as possible.” Pai made good on that promise in December, when he orchestrated the FCC vote that repealed the 2015 order.

BEHIND THE DECISION


The main argument made by Trump’s FCC was that net neutrality compliance has bogged down ISPs, thus slowing innovation. The FCC’s official press release announcing the repeal states that “the regulatory uncertainty created by utility-style Title II regulation has reduced ISP investment in networks, as well as hampered innovation.”

While many ISPs have indeed complained loudly about net neutrality, Pai offered little data in the run-up to the vote backing up his assertion that the new regulatory framework has been bad for business, citing instead conversations he’s had with individual ISP CEOs.

Actually, ISPs seem to have done just fine over the last two years under Title II. A look at the balance sheets of the “big three” ISPs (AT&T, Comcast, and Verizon) shows that two have grown their capital expenditures in the years since the Open Internet Order. Comcast’s capex was 28% higher in the three years following the order’s rollout (2015-2017: $26.9 billion combined) than in the three years prior (2012-2014: $21.0 billion). Verizon, likewise, upped its capex by 3% in 2015-2017 ($50.7 billion) compared to 2012-2014 ($49.1 billion). And AT&T likely would have seen its capex grow between the two periods if not for a costly one-time network upgrade in 2012-2014.

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Net neutrality opponents counter that much of the industry’s capex in recent years has come not in the form of infrastructure improvements, but rather of mergers and acquisitions. After removing the financial impact of deals such as AT&T-DirecTV and Comcast-NBCUniversal, economist Hal Singer finds that the capex of the top 12 U.S. ISPs actually declined by $3.6 billion from 2014 to 2016.

But this is probably a distinction without a difference. ISPs clearly have plenty of money to spend, and they are spending it more than ever; they’re simply choosing to spend it on M&As. More importantly, the trend toward huge ISP megadeals—which is all about the industry becoming less competitive—itself speaks to the need for policymakers to keep monopolistic pricing power in check. (We’ll revisit this topic later.)

What about qualitative evidence, alluded to in the conversations Pai had with unhappy ISP CEOs? Here too, we find little reason to believe that ISPs were hampered by the Title II designation. Massive projects to roll out broadband Internet to underserved areas (like the one undertaken by AT&T earlier this year) simply would not have been possible without significant ISP investment. Some ISPs themselves downplay the negative effects of net neutrality: Comcast CFO Mike Cavanaugh admits that “the fear of what Title II could have meant” has had more of an impact on Comcast’s business than the reclassification itself. Quite simply, according to S. Derek Turner of consumer advocacy Free Press, “[N]ot a single publicly traded U.S. ISP ever told its investors (or the SEC) that Title II negatively impacted its own investments specifically.” Even the cable industry’s top lobbying group brags that average U.S. broadband speeds, thanks to robust ISP innovation, have recently been rising at a record clip.

THE LEGAL PATH FORWARD


In the immediate future, the controversial FCC decision will be contested in the courtrooms and on the Congress floor. Legal challenges against the ruling, in fact, are already underway. Experts say that these challenges are likely to fall into two types of categories.

The first type targets the validity of the decision itself. Columnist Clint Finley reports that advocacy groups will say the net neutrality repeal violates federal laws barring “arbitrary and capricious” regulations—that is, regulations unsubstantiated by data. As Hedgeye Senior Telecom Analyst Paul Glenchur wrote in a recent note, “A shift in political power at a regulatory agency is not a sufficient legal basis to sustain rule changes.” In essence, for the repeal to stick, the FCC must have been spurred by more than mere partisanship.

Still, it’s difficult to predict how the courts will actually rule. The FCC did give a reason for the repeal—that net neutrality stifles innovation. And whether or not the FCC has actually adduced evidence to back its claim, the appeals court may very well defer to the agency’s expertise. Could the case go all the way to the Supreme Court? Possibly—but Pai maintains that the highest court in the land will rule in the FCC’s favor. There’s some legal precedent to support his belief: In 2005, the only previous instance in which the Supreme Court weighed in on the classification of ISPs, it deferred to the FCC’s authority to define ISPs however it wishes. The message: As long as the FCC makes a coherent argument, the courts are unlikely to dig deep into the data to shoot the argument down.

Congressional action aimed at the FCC repeal is also in the pipeline. Representative Mike Doyle (D-PA) says that he will use the Congressional Review Act (CRA)—which affords Congress the right to undo recently instituted regulations—in order to fight for net neutrality. (This act has become a staple of the 115th Congress: Used successfully only once prior to 2017, the CRA has since been used to overturn 15 regulations.) But of course, any use of the CRA would have to be supported by a majority of the House and Senate—and even then would be subject to a presidential veto. Alternatively, Representative Marsha Blackburn (R-TN) recently unveiled a bill that would restore the no-blocking and no-throttling provisions of the 2015 order.

The second type targets the decision-making process. Critics could also challenge the decision on the grounds that the FCC’s process was unfair or flawed. Indeed, many believe that the public commentary period—the only time during which everyday consumers could voice their concerns to the FCC prior to the vote—was compromised, and that the FCC vote was rushed through nevertheless.

The public commentary period was indeed marred with problems. A Pew Research Center analysis finds that, of the record 21.7 million comments submitted by the public, 57% used temporary or duplicate e-mail addresses. The FCC’s two Democratic commissioners, Mignon Clyburn and Jessica Rosenworcel, have each decried the process: Rosenworcel maintains that 500,000 public comments came from Russian addresses and that another 50,000 vanished mysteriously from the ledger. In a similar vein, New York Attorney General Eric Schneiderman is planning a multistate lawsuit on the grounds that the organization failed to allow fair and open commentary from the public.

WHAT WOULD A POST-NEUTRALITY WORLD LOOK LIKE?


Unless an emergency stay is granted by a federal court (a course of action that Hedgeye’s Glenchur says will likely fail), the FCC’s repeal will become effective 60 days after publication in the Federal Register. Thus, at least for the near term, we will be living in a post-neutrality world. What would it look like?

The FCC has taken pains to assure critics that not much will change. The agency says there’s no proof that ISPs will abuse their newfound power. In an interview earlier this year, Pai said that “we don’t see evidence of [violations of net neutrality] happening in the marketplace on a widespread level.”

What’s more, the FCC believes enough safeguards remain in place to protect businesses and consumers. After all, even as a more lightly regulated Title I service, broadband provision will still fall under the authority of the Federal Trade Commission (FTC). The FCC also plans to stay in the fold by way of a joint effort with the FTC to “take targeted action against bad actors.” Finally, the FCC maintains that a world without net neutrality won’t look any different to end users: Pai released a video on the eve of the vote showing “7 things you can still do on the Internet after net neutrality,” including Instagramming your food and posting memes.

But this rosy scenario doesn’t stand up to scrutiny. For one, the argument that ISPs will treat the consumer unfairly (what Pai denies) is not a hypothetical—we’ve already seen it happen. In 2014, Netflix paid Comcast a fee in order to boost its steadily deteriorating download speeds. In 2012, AT&T tried blocking FaceTime among iPhone users who didn’t have a shared data plan. In 2007, Verizon was found to have blocked text messages from a pro-choice advocacy group. That same year featured the Comcast-BitTorrent lawsuit. The list goes on. The message: Without express rules preventing these types of practices, there’s no reason to expect ISPs to play nice.

Furthermore, the FTC is hardly a viable substitute for the FCC on net neutrality. The FCC is an ex-ante agency that drafts regulations to prevent wrongdoing. The FTC is an ex-post agency that tackles issues retroactively. Under the new paradigm, the FTC can only take action if ISPs violate net neutrality promises made in their terms of service. There’s nothing, however, requiring ISPs to make such promises in the first place. Sure enough, the day that Pai announced the first version of his repeal proposal, Comcast deleted a three-year-old “no paid prioritization” statement from its website. In the words of Jessica Rich, former director of the FTC’s Bureau of Consumer Protection, “[A]s someone who spent more than 25 years enforcing the law at the FTC, I know there’s a serious problem with touting the FTC as a substitute for the [FCC].”

WINNERS AND LOSERS IN AN ANTI-NEUTRALITY WORLD


Net neutrality’s imminent repeal creates a number of winners and losers. Who stands to gain or lose the most in the immediate future?

Obvious winners: Large ISPs. The biggest, most obvious winners will be large ISPs. Not only will these companies now be allowed to block, throttle, and practice paid prioritization so long as they disclose such agreements in their terms of service, but they will also be freed from common carrier statutes that prevented them from discriminating against certain users or charging too much for their service. Quite simply, these firms will have more leeway than ever to maximize profits, even if it comes at the expense of certain groups of consumers.

Firms like a combined AT&T-Time Warner (assuming the merger ever goes through)—those that own not just the “pipes” but also the content flowing through those pipes—will be particularly well positioned. As The New York Times points out, a combined AT&T-Time Warner could, for instance, prevent rivals like Dish Network from receiving premium HBO programming, implicitly favoring its own DirecTV satellite plans. (This type of scenario is already a reality in the world of wireless phone service, where it goes by the name of “zero-rating.”) It’s no wonder that the nation’s largest ISPs are now singing the FCC’s praises.

Just as the largest ISPs will benefit the most from the repeal, the smallest ones will benefit the least. Not only will they be unable to utilize their scale to command high fees on par with the ones captured by companies like Comcast, but they also risk falling further behind these giants. In fact, in an interesting twist, a group of 30 small ISPs sent a letter to Pai in June urging him to preserve the net neutrality rules, contending that they are necessary “to address the anticompetitive practices of the largest players in the market.”

Dark-horse winners: Large edge providers. Net neutrality seems like it would be a natural fit for large “edge providers” (companies like Facebook that build and monetize Internet-based services). These are, after all, the Democratic-leaning Silicon Valley tech firms that couldn’t have gotten off the ground without a wide-open Internet. Today, these same firms derive their scale and their profit from the millions of users who access their online site. Indeed, in earlier iterations of the net neutrality debate, high-powered Silicon Valley CEOs were often on the front lines of the pro-neutrality brigade.

But something has changed this time around. While most of these firms still nominally support net neutrality, the majority stayed silent in the months leading up to December’s FCC vote, pointing instead to statements made by their industry trade group, the Internet Association. And many of the largest firms have been the most conspicuously absent from the debate: The extent of Google’s net neutrality activism was sending a lone e-mail to followers of the company’s “take action” policy website. (To be sure, now that the repeal has become official, these companies reportedly plan to take a stronger stand against the FCC.)

Why? The answer comes down to their growing size and scale. Even without net neutrality regulations, these digital giants know that they will be part of whatever basic ISP package is offered to consumers. (An ISP wouldn’t dream of excluding Google, Facebook, Netflix, or Amazon.) As Forbes contributor Tim Worstall pointed out in 2014, “[Facebook is] perfectly happy with not having net neutrality when Facebook is one of the privileged services to which people gain greater access.” Netflix chief executive Reed Hastings admitted as much when he stated frankly that net neutrality is no longer the company’s “primary battle…because we’re big enough to get the deals we want.”

An open Internet, therefore, may no longer be of interest to the giants. One could even argue that it has become a hindrance. An ISP monopoly would not only help the giants crowd out their digital competitors—but may also pay them a subsidy (a sort of monopoly rent sharing) as part of the bargain.

Losers: Small edge providers. OK, so if you’re Facebook, you’ll probably be fine in a post-neutrality world. But what if you’re one of the innumerable small fish that make up the rest of the Internet?

These companies fear that paid prioritization will ultimately deal them out. The nightmare scenario for small edge providers is that consumers who were once getting their content for free with a basic broadband subscription may have to pay extra if they want to spring for the “whole Internet” package. No less threatening is the possibility that their website’s traffic may be placed in a “slow lane” to make room for a giant company like Netflix that can afford to pay for ultra-fast Internet service. It’s little surprise that, in August, the American Sustainable Business Council and other small business groups published an open letter to the FCC, contending that the repeal of net neutrality regulations would be “disastrous.”

Losers: The general public. Whatever the impact on businesses, the cost of the net neutrality repeal will ultimately be shouldered by consumers. Edge providers that cannot afford the hefty fees imposed by ISPs will be forced to raise the prices of their user-facing services. And ISPs will be able to create tiered packages that could force users to pay more than they’re paying today for access to premium content. According to IT expert Jonathan Hill, “[E]veryone is going to get to pay for the bronze, silver, and gold package… And if you don’t have the gold package, good luck catching up on Game of Thrones.”

Consumers seem to grasp these negative implications. A University of Maryland poll taken before the FCC vote found that 83% of survey respondents oppose the possible effects of a net neutrality repeal, including 89% of Democrats and 75% of Republicans. (Net neutrality is one of the few issues that cuts across political partisanship.) As opposed to some of the murkier polls cited by net neutrality skeptics, this one was lauded for clearly explaining the pros and cons of net neutrality—the message being that when consumers know what net neutrality is, they want it.

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The general public’s support of net neutrality was particularly evident in the months leading up to the FCC vote by way of a massive grassroots effort to raise awareness. Called to action by nonprofits like Free Press and Demand Progress, millions of consumers raised their concerns on social media, wrote letters to the FCC, and even staged formal protests outside of Verizon stores. (Pai was formerly employed as a lawyer for Verizon.) As Columbia law professor Tim Wu puts it, “The FCC, in short, is on the wrong side of the democratic majority.”

Support for net neutrality extends across all demographic categories. A recent HuffPost/YouGov survey finds that, while nobody seems sure of how they want the Internet to be regulated (this is again dependent largely on the phrasing of the question), most everyone agrees that net neutrality is a net positive. This is particularly true of Millennials: Of all consumers who have heard of net neutrality, 18- to 29-year-olds are the least likely to say that they supported its repeal, with just 13% saying that they “strongly” or “somewhat” supported the FCC’s decision. This share rises only slightly by age, with 27% of the 65+ saying that they supported the repeal. Younger consumers are also the least likely (16%) to support the creation of Internet fast lanes, with 66% either strongly or somewhat opposed.

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Net neutrality meshes with many aspects of the Millennial mindset, from their love of the open Internet to their desire for equal treatment. For many Millennials, their fervent support of net neutrality has been one of the few issues that has actually gotten them politically engaged. Many political pundits even believe that net neutrality could give the Democratic Party a platform it could use to win over young voters, providing hope ahead of the 2018 midterms.

To be sure, some young adults do notice a sense of complacency among their peers when it comes to net neutrality: Millennial columnist Claire Hoffman believes that her generation is so used to treating Internet access as an unalienable right that it seems inconceivable that ISPs could significantly affect the online experience. All the more reason, she says, to take an active role in the debate.

One need only look abroad for a preview of an Internet without net neutrality. In many emerging markets, consumers have a severely limited view of the Internet by U.S. standards. Through services like Facebook Zero and Google Free Zone, consumers are given free access to a curated, company-approved Internet and must pay extra for the real deal. (In emerging markets like Nigeria and Indonesia, two-thirds users agree that “Facebook is the Internet.”) China’s “Great Firewall” blocks—or, more insidiously, slows—content unapproved by state regulators. Last year in Morocco, telecoms colluded to restrict access to Web-calling services like Skype because these services competed with their own phone businesses. Meanwhile, this viral photograph of Portugal’s Internet shows different “bundles” that subscribers can choose based on their data usage. Love streaming videos? You might want the video package—which includes services like YouTube and Netflix, but excludes options like Hulu and Amazon Video.

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THE BEST ARGUMENT AGAINST NET NEUTRALITY


All of the above discussion is solely predicated on the recent official repeal of net neutrality. But let’s shift gears for a second. Aside from the immediate fate of the FCC ruling, there’s also a broader conceptual debate. Which argument—pro- or anti-net neutrality—actually makes sense? And which future for ISPs, regulated or unregulated, is likely to be sustainable over the long haul?

Let’s begin with the best argument of the net neutrality critics, who basically complain that their opponents don’t understand how the Internet works. “Net neutrality,” they say, erroneously assumes a world in which ISPs can literally refuse to differentiate at all between various types of Internet traffic. But such a world does not exist.

Consider, for example, the vastly different demands of e-mail versus video streaming: The former is low-bandwidth with plenty of wiggle room when it comes to latency (nobody cares if their e-mail is a few milliseconds late), while the latter is high-bandwidth and cannot function without near-perfect latency. Shouldn’t Netflix be allowed to pay extra to ensure that its service always gets the high priority it needs—and conversely, shouldn’t Microsoft be allowed to pay less for a service like Outlook that doesn’t need high priority? Fortune contributor Brian Chamberlain points out that the need to differentiate between types of traffic will grow even starker in the coming years as the number of Internet-connected devices multiplies, thanks to the growth of the Internet of Things.

In fact, tech experts often point out that “fast lanes” and “slow lanes” have been expressly built into the modern Internet. In the Web’s infancy, engineers—realizing that not all traffic was created equal—built a differentiated services protocol (or “DiffServ”) that would allow ISPs to easily classify and sort traffic. In the ensuing years, as a few giants like Google and Facebook became responsible for an ever-greater share of all Internet content, ISPs were forced to optimize the way that these providers were integrated into the system. The solution came in the form of “peering connections” and “content delivery servers,” which essentially allow dominant Internet companies to host servers within the ISP. (Companies from Google to Facebook to Pandora all have these direct connections.) According to tech columnist Robert McMillan, in many ways, “The net neutrality debate is based on a mental model of the Internet that hasn’t been accurate for more than a decade.”

This is a good argument—valid as far as it goes. But it does presuppose an extreme caricature of what net neutrality supporters advocate: They want regulations prescribing absolute “neutrality” across all information whatsoever. And since that is unworkable, any regulation to get what they want is unworkable. As a shorthand for this logic, many GOP leaders say that net neutrality is nothing but a flimsy pretext to get government into the telecoms. According to a tweet from Senator Ted Cruz: “‘Net neutrality’ is Obamacare for the Internet; the Internet should not operate at the speed of government.”

THE BEST ARGUMENT IN FAVOR OF NET NEUTRALITY


In fact, most net neutrality advocates are concerned with something more fundamental than whether or not ISPs should—in reality or in principle—be allowed to block, throttle, or practice paid prioritization. Rather, their concern is about how these companies will inevitably behave when they have unrestricted power over their regional markets. To the extent they have such power, advocates argue, ISPs can be expected to roll out predatory pricing schemes, exert pressure on content creators, and otherwise arbitrarily control the free flow of information through their digital pipes.

In other words, the debate about net neutrality is really a debate about industry competition—or a lack thereof. As Silicon Valley entrepreneur Jamie Finck recently put it, “It’s important to understand how the lack of broadband competition has forced us into an untenable situation where a near-monopoly on home internet access puts giant service providers in a position to limit or filter our access to the internet. Net neutrality would be far less critical an issue in the U.S. today if we had adequate competition and consumer choice for home broadband delivery.”

Granted, the saliency of this issue was obfuscated by the FCC’s original move to reclassify broadband providers as common carriers. It came across as a tactical ploy: The agency only designated ISPs as Title II companies after it had failed to exert its regulatory power on these firms in other ways. But as we’ll show below, it is very likely that Title II “common carrier” regulation for the ISPs was inevitable sooner or later. Why? Because ISPs now constitute a natural monopoly. And because common carrier regulation is how policymakers have historically responded—indeed, have been compelled by consumers to respond—to such monopolies when they arise.

Economists and case law teach that there are three main “tests” that policymakers use to determine the presence of a natural monopoly.

Test #1: Is there competition? The first test is whether or not there’s competition for what is considered to be a basic product or service. In this case, “basic” means 25 Mbps Internet service, which the FCC defines as the minimum speed required to be considered “broadband.” If consumers have any real choice as to their broadband provider, then they should be able to “vote with their wallets” against any ISP that practices predatory pricing.

But the available data show that, in most of the country, consumers have no such voting power. The FCC’s annual Internet Access Services report shows that 58% of U.S. census blocks with residential housing units are served by no more than one 25 Mbps provider—read: no competition. Dividing up America by household rather than by census block yields similar results: Research done by Hal Singer using separate FCC data shows that roughly half of U.S. households (48%) have no more than one 25 Mbps provider. A significant share of households (20%) have no wireline broadband competition whatsoever, regardless of speed. By any standard used by the FTC or Justice Department to define “market competition,” these figures are way into the red zone.

Although 25 Mbps may be what the FCC uses to define broadband, any service tech will tell you that most professional families require more bandwidth. Hi-def video streaming will eat up most of this bandwidth on its own—and that’s not adding in the various smartphones, tablets, games, and computers a family may possess. Tech website Engadget recommends that households with “many” connected devices (as a typical family does) have broadband service of at least 25 Mbps.

So what happens when we look at competition at higher speeds, say in the realm of 100 Mbps? At these speeds, there’s practically no choice at all: Fully 9 in 10 census blocks, to go along with 8 in 10 households, are served by one or fewer fixed 100 Mbps providers.

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Outraged USA Today commenter Robert Lott sums up the predicament that consumers face: “‘Vote with your wallets,’ really? The vast majority of Americans do not get appropriate alternatives. It’s like saying, if you don’t like the price of airlines you can vote with your wallets by driving. Yes, it’s feasible, but going across the country by car isn’t really an option.”

What’s worse, even when there are alternatives, ISPs often make it difficult, if not impossible, to switch. Your broadband service is probably tied to your TV, phone, and cable service. Deciding to switch providers means paying for all new equipment (from cable boxes to installation fees), not to mention the dreaded “early termination fee.” Such costs may make it uneconomical for the consumer to switch in response to all but a vast difference in price or options.

Test #2: Is the service essential? The next question to ask in determining monopoly power is whether the service in question is essential. This isn’t a value judgment. Economists deem a service to be essential if it has a low “demand elasticity” with respect to price. If it does, demand doesn’t vary much as the price rises or falls—reflecting the fact that the consumer really needs it and cannot easily find a substitute for it. Electricity, water, and gasoline are all essential according to this definition (though gasoline at the retail level is not a monopoly since the gas station market is typically very competitive).

So is broadband an essential service? A quarter-century ago, when the Internet was frequented mostly by programmers and early adopters, the answer would have been no. But today, when most Americans use the Internet to do a wide variety of basic daily tasks—going to work, paying bills, getting news, communicating with each other, to say nothing of entertaining themselves—the answer is clearly yes. Pew data show that, among working-age Americans, almost everyone uses the Internet today—99% of 18- to 29-year-olds, 96% of 30- to 49-year-olds, and even 87% of 50- to 64-year-olds.

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This recent yet growing popular dependence on the Internet makes most customers price takers. The Internet, arguably, is at least as essential to most Americans today as many other essential services were at the time that they became subject to common carrier regulation—from the postal service and the telephones to the railroads and the gas lines.

Test #3: Are there barriers to entry? Even an essential service in a noncompetitive industry is not necessarily a monopoly. What also has to be shown is that, if a supplier abuses its pricing power, new suppliers cannot easily enter the market to provide consumers with alternatives. A third criterion for the presence of a monopoly is therefore high barriers to entry.

Here again, we find that the ISPs pass the monopoly test with flying colors. They have sky-high barriers to entry that expressly favor the incumbents. It’s not just the usual challenge of “scaling up” and committing to huge fixed investments like laying cable, either.  It’s about pricey “pre-deployment barriers” that keep the big guys safe from newcomers. These barriers include, among other things, negotiating rights of way with local government officials, as well as seeking pole attachment contracts with public utilities that can effectively double the cost of building a network. And then there’s the matter of the frivolous lawsuits routinely filed by big ISPs for the express purpose of overloading smaller competitors with insurmountable legal costs and delays.

Look no further than the failings of Google Fiber: If any newbie could shake up the ISP industry, it should have been the big-thinking, big-spending Google. But the company has pulled back on its Fiber plans due not just to excessive capex projections but to an interminable legal gauntlet.

If we can agree that the real issue is competitiveness, it changes the likely economic consequences of the FCC’s decision. And it changes the direction in which the debate may shift.

Economic consequences? For the time being, we can expect the ISP telecoms to use their new freedom to exploit their growing pricing power (by such means as zero-rating, pay-for-play, tiered services, and package deals with the digital giants like Google) and maximize their bottom lines. We can also expect an acceleration in any M&As that have a chance of passing muster with the FTC and Justice Department. Many ISP execs no doubt suspect that their window of good fortune may temporary—so this is the time for them to move rapidly to gain ground in local markets.

As for FCC Chairman Pai’s suggestion that consumers should rely on the goodwill of ISPs not to exploit their pricing power, this is nonsensical. ISP executives would be betraying the trust of their directors if they did not exploit these legal opportunities. To paraphrase Adam Smith: It is not from the benevolence of our Internet service providers that we expect our Facebook and our Netflix, but from their regard to their own interest.

Changes in the debate? The net neutrality critics will lose if they do nothing more than complain about the horrors of government regulation. The concept of common carrier regulation has a very long historical pedigree. It goes back to the Middle Ages, when ferry operators and bridge owners were subjected to regulation preventing them from profiting unfairly from their advantage. In the United States, it first arose at the federal level when railroads were designated as such in 1887—and has since been extended to various other industries. It is a blunt instrument. But history shows that when consumers believe they are being treated unfairly, they will vote to use it.

To quote from Wired: “Those who oppose [Wheeler’s net neutrality] decision say he went overboard by pulling out a big club used to smash 19th- and 20th-century monopolies, not to nurture and fine-tune modern tech providers. But what if those modern tech providers are, in fact, acting like monopolies from 100 years ago?”

If the critics of net neutrality want to avoid regulation, what they ought to do is come up with some bold strategies to make the ISP industry more competitive. This might include radical proposals to break up the big telecoms, to oppose new telecom mergers, or perhaps to force ISPs to lease the “last mile” of their infrastructure to competitors. (Known as “local loop unbundling” this strategy helped to break AT&T’s old telephone monopoly.) At the very least, they could insist on a federal override of local government roadblocks that make it very difficult for new competitors (recall Google) to emerge.

Thus far, few on the GOP side of the debate have declared that consumers would benefit from more ISPs to choose from. Chairman Pai, while an energetic supporter of new investment and services, has rarely if ever suggested that the industry needs more competitors. This refusal is odd for the party of Adam Smith. And it is misguided for the party that wants to avoid “Obamacare for the Internet”—since it may lead to exactly that.

WHAT COMES NEXT?


As we’ve discussed, the two sides of the net neutrality debate are currently arguing past each other. The anti-neutrality side is basically saying that the pro-neutrality side doesn’t understand the Internet, is fabricating a pretext for a government power grab, and is wrong not to trust the ISPs to play fair. The pro-neutrality side is basically saying that the anti-neutrality side doesn’t understand economics, is fabricating a pretext for ISPs to abuse their monopoly power, and is wrong not to expect ISPs to act in their own self-interest.

Oddly enough, both sides may be mostly right. The anti’s may be correct that most of the pro’s don’t understand the Internet and don’t mind enlarging the administrative state. But the pro’s are also correct that most of the anti’s, in flagrant disregard of the free-market economics they espouse, do provide cover for a large industry to exploit a monopoly pricing advantage at the expense of consumers.

Given that the anti’s have won the debate, for now, what comes next?

For the next six months, the answer lies largely in the courts and in Congress. The courts, as we have seen, are unlikely to resolve this issue quickly—and if they do, it will probably be in favor of the anti’s. Congress, meanwhile, is also unlikely to act quickly. The votes of the hard-core red-zone and blue-zone—anti’s and pro’s—will not change in any case, and the moderates will want to wait for the issue to work its way fully through the court system. Pro’s know that they have little chance of changing policy while Trump remains president and they remain in the minority.

Come the 2018 midterm campaign season, however, net neutrality may light up again as a very live political firestorm. Democrats have been lobbed the perfect softball: a bipartisan issue that casts congressional Republicans as villains in league with America’s most reviled companies. The odious reputation of ISPs is the stuff of legend: The American Customer Satisfaction Index gives U.S. telecoms the worst composite customer service score of any industry. Early last year, financial website 24/7 Wall St. named Comcast America’s #1 most hated company, with other ISPs such as Dish (#8) and Charter Communications (#12) faring little better. Net neutrality could be the Democrats’ chance to side with the consumer and the small business website owner against the odious tycoons.

Don’t underestimate the incendiary appeal of net neutrality. There’s a track record here. Recall that the 2015 Open Internet Order’s passage was very much influenced by an intense grassroots effort that, according to Craig Aaron of Free Press, “broke the FCC’s website, jammed switchboards on Capitol Hill, and forged new alliances that are transforming how telecom and technology policy is made.” Recall as well the intense grassroots campaign in 2011 that sank SOPA (Stop Internet Piracy Now) that came as a total surprise to big media companies like Viacom and Disney who thought that this was a slam dunk.

For Congressional Democrats, the choice is easy. On one side is net neutrality, uniformly backed by the general public. On the other side are hated ISP barons, mixed in with the lingering fear of a censored or “prioritized” Internet like what’s available in so many authoritarian regimes around the world. Even if net neutrality is not resolved soon and seeps into the discourse surrounding the 2020 presidential elections, it has the potential to help redefine the political landscape for years to come.