FCC should fold its losing hand

The proponents of “net neutrality” have done a great job of convincing the world that future of mankind — or at least USA’s national competitiveness — depends on the ability of the Federal government to tell broadband carriers what they can or cannot do to manage their networks.

Thus, the media has been predicting catastrophe for net neutrality after the unanimous decision Tuesday by the D.C. Court of of Appeals on Comcast v. FCC, in which the reversed the FCC order that Comcast not block BitTorrent. (Unlike most, CNET managed to find two sides to the story.)

The problem for the FCC is that there was no legal basis for its action. The 3-0 Appeals ruling concluded:

Yet notwithstanding the “difficult regulatory problem of rapid technological change” posed by the communications industry, “the allowance of wide latitude in the exercise of delegated powers is not the equivalent of untrammeled freedom to regulate activities over which the statute fails to confer . . . Commission authority.” NARUC II, 533 F.2d at 618 (internal quotation marks and footnote omitted). Because the Commission has failed to tie its assertion of ancillary authority over Comcast’s Internet service to any “statutorily mandated responsibility,” Am. Library, 406 F.3d at 692, we grant the petition for review and vacate the Order.

Translation: the FCC gave a laundry list of reasons why it had authority to regulate Internet carriers, but in no cases did Congress ever give them statutory authority.

This was, in fact, predicted by the dissent in the sharply divided 3-2 FCC vote in August to go after Comcast. As CNET reported at the time:

In an unusually pointed dissent, Commissioner Robert McDowell, a Republican, said the FCC's ruling was unlawful and the lack of legal authority "is sure to doom this order on appeal." …

The is the FCC's "journey into the realm of the unknowable," McDowell said, saying that the outcome "may result in slower online speeds" for most Americans.

The problem is, despite all the lawyers involved, the FCC majority and its allies are pursuing an end-justifies-the-means strategy: it is right that the government regulate carriage of data over broadband carriers, no matter what the law says.

The FCC is now considering two options around the ruling. One is to appeal to the Supreme Court, while another is to reclassify broadband as a different type of service and try again. Both could end up with the same result.

To an outsider, the answer is obvious: if the law says the FCC doesn’t have authority over Internet services, then the FCC should stop trying to weasel out of the law and instead go through the Constitutional process to change the law.

After C-SPAN and the other media cover the Congressional hearings, our elected representatives will come up with something that considers all the competing perspectives. That’s what a democracy is about, not having an unelected regulatory agency interpret, stretch or ignore the law as it sees fit. (The solution won’t be perfect, but then neither will any FCC order).

In the meantime, the market will do what it usually does: solve problems on its own, with both competitors and the real threat of regulation prevent excesses. As the Merc quoted one trade group leader:

"The idea that this ruling will invite bad behavior is nonsense," said Bruce Mehlman, a former assistant secretary of commerce for technology policy during the Bush administration and now co-chair of the Internet Innovation Alliance. "Companies need to manage their networks to handle high volumes of traffic and bona fide threats out there, but we're simply not going to see blocking or degrading of disfavored sites. It would be bad business and it would beg for regulatory overkill."

There was similar sturm und drang over mobile carriers blocking VoIP services such as Skype. But in the face of overwhelming consumer demand, the carriers have given up their futile fight against VoIP.

One radio account said that a possible outcome of the Comcast decision is variable-rate pricing, in which home broadband users pay more for faster or greater data transfer. What’s wrong with that? That’s the only thing that’s going to save 3G data services from negative externalities, and home broadband — or at least the shared bus cable TV internet — will similarly collapse in download of multi-gigabyte HD movies.

Net neutrality to preserve the status quo

Holman Jenkins is right. The big industry money fighting to get the FCC to impose net neutrality comes from powerful incumbents who want to preserve the status quo:

Google has been one of the most influential net-neut proponents. It recently secreted its top lobbyist, Andrew McLaughlin, into a White House job as deputy head of telecom policy. But Google also understands, as its chief Eric Schmidt recently put it, "It's very, very important that the telecom operators have enough capital to continue the build-outs."

Google's trick will be to lobby for the optimum of Internet socialism—"tiered" pricing may be OK, in which some consumers pay extra for a bigger pipe. But usage-based pricing that would give consumers a reason to think twice before clicking on a Google-sponsored ad? It would be the end of Google's business model.

And Google has allies. The greatest fear of Microsoft, Amazon, eBay and Yahoo is having to plumb their deep pockets and offer competing payments to broadband carriers to speed their bits to consumers. They much prefer spending their money to sprinkle server farms around the globe, assuring fast, reliable access for their customers in a way that no newcomer can easily replicate.

What if some startup Google sought to achieve the same goal by outsourcing its data management to the telecos, say, by mounting servers in their premises to help deliver Web applications more quickly? This would be a win-win for both parties. Data that travels within a carrier's system is cheaper to deliver than data that must be handed off between two or more carriers.

I often disagree with Jenkins, but today I think he’s right on the money. The successful dot-com incumbents are quite happy with the current Internet distribution and cost structure, and want to avoid any change that might threaten their power of incumbency.

Another point he alludes to only in passing: the dot-com winners don’t want to change an allocation of spoils between their high margin, highly scalable (network effects) business to give more to the capital-intensive operators that supply the essential last mile infrastructure they must have.

Both GOOG and T have gross margins of 60%. However, Google’s operating profit (EBIT) is 26.7%; AT&T (due to high SG&A plus depreciation) has an operating profit ratio of 18.6% and Verizon a mere 11.9%.

Latest in a series of outsourced economic policy criticism as a cost-cutting move during difficult times.

Arbitrary telecom regulation

Perhaps the above title is a redundant description, given that everyone knows that telecom is highly regulated, that the regulatees spend huge sums to loosen that regulation and their competitors (including other telecom companies, Google etc.) spend money to increase the regulation.

Still, some of the observations today about the FCC were very interesting — even for someone like me that’s researched and written about US telecom policy for the past 13 years. I spent this morning at the State of the Net West conference, hosted by (and at) the Santa Clara University law school.

The second panel was “Antitrust in the Internet Era,” and the lead-off speaker was Rep. Zoe Lofgren (D-San Jose). With a US Chamber of Commerce rating of 37%, Rep. Lofgren is not a business-friendly legislator overall. However, like a lot of Peninsula Democrat politicians, she has a soft spot for local high-tech companies (which provide high-wage employment in her district and the largest share of her campaign contributions).

Still, I was pleasantly surprised when Lofgren spent some of her time focusing on the chilling effect of regulators’ threats. She noted that nowadays, the greatest impact of antitrust enforcement comes from the threat of an enforcement action rather than taking actual action. She also noted that (if I caught it correctly) the antritrust inquiries are often driven by the concerns of rivals, with its obvious potential for abuse.

But the most damning remarks came from Prof. Michael Katz, the Berkeley economist who (with book author Carl Shapiro) invented the concept of network effects with their oft-cited 1985 paper. Katz spoke from his unique perspective on telecom regulation, having served as deputy assistant attorney general for economic policy in the Department of Justice (2001-2003) and chief economist of the FCC (1994-1996).

Katz made two important points bearing on FCC arbitrariness. (Arbitrariness being my word, not his).

The first is about the unpredictability of the FCC review process. Katz said the timing of merger regulatory approval by the DoJ is proscribed by law under HSR, and thus (as a consultant) there is a very tight deadline to get analysis done by a specific time. On the other hand, for FCC regulated mergers, the review process much more leisurely, because the process is open-ended and the parties can’t do anything until the get FCC approval.

The second was even more damning. When reviewing mergers, Katz noted

• “The FCC is a much less disciplined"
• “It pursues its decisions [with] much less use of the facts.”
• It makes “much greater use of threatening companies when it couldn’t prove it court”.

(The FCC has a habit of getting its regulatory decisions overridden in courts — most famously in indecency, but also in net neutrality and cable TV regulation.)

Katz concluded that the FCC “has a tremendous amount of power [that it can use] to essentially blackmail companies,” a position that he said that former FCC head Michael Powell also held. (In a quick search, I couldn’t find any public statement by Powell to that effect).

While Stanford economist Tim Bresnahan did not endorse Katz’s specific criticisms of the FCC, he said that government power must "be adequately constrained”. In particular, merger review should focus on the US standard of review — i.e. will the merger help/hurt consumer welfare? (When I openly asked Tim whether there were any cases in the past year where the competitor-focused EU antitrust standard would have helped consumers, he answered in one syllable: “No.”).

What was particularly striking was the divide on antitrust policy (and other policies) between the lawyers and economists. There were the two famous economists on the panel (and one obscure economics blogger in the audience), but we were clearly outnumbered by the lawyers — three panelists from the SCU law school and three J.D.-toting members of the House.

The economists argued from the standpoint of evidence, efficiencies, outcomes and results. (The token business and GOP representatives supported the same policies but did not make as strong an intellectual case).

The lawyers argued from anecdote, personal opinion, and beliefs. (In this matter, Rep. Lofgren was far disciplined than her colleagues). In other words, issues that he/she thinks are important are the ones that the law and policy should consider. This plays to the myth of the all-knowing, all-powerful benevolent regulator being the best way to remake society.

A great example of this came with grousing by audience and panel that repeated recent complaints about the closed nature of the iPhone (notably the Google Voice controversy). However, this is not a market failure or abuse of power. For every developer (or user) who gets fed up with the iPhone platform, there are choices like Android, Blackberry and Symbian — something that the competing platform owners know and use as a way to get adoption.

As Katz himself noted, “This is notion that iPhone is dominant handset … is just wildly overstated.” He predicted that a claim of a violation of an antitrust law “would never hold up in court” and thus the Justice Department won’t even investigate it. [Perhaps because the iPhone has less than 25% marketshare in the US — even if you count only smartphones — and less than 1% of the global mobile phone market..]

In other words, there’s no justification for government intervention if there’s no market failure. Meanwhile, there is no plan to intervene to fix the arbitrariness of FCC regulation.