Benjamin Studebaker

Yesterday, US President Barack Obama came out in favor of net neutrality, urging the FCC to classify the internet as a utility for regulatory purposes:

Immediately thereafter, Senator Ted Cruz (R-TX) came out against net neutrality, tweeting:

“Net Neutrality” is Obamacare for the Internet; the Internet should not operate at the speed of government.

This analogy between net neutrality and Obamacare does not work on any level and is deeply misleading. Here’s why.

Let’s start by explaining what net neutrality is and how it works. Net neutrality is best explained with an illustration of what can happen if you don’t have it, so here’s a parable.

Let’s say that you’re a major cable, phone, and internet provider, like Comcast. Comcast’s business model has been under stress in recent years due to changes in consumer behavior. Many consumers are ditching their landline phones. In late 2010, 29.7% of Americans had no landline phone. In late 2013, that figure had increased to 41%:

If consumers continue to ditch landlines at that pace, companies like Comcast will not have phone businesses by 2032. To make matters worse for the cable companies, many people are now “cutting the cord”–abandoning their cable and satellite packages in favor of online streaming services like Netflix.While only 8.6% of US households did without subscription TV in 2011, 14.1% do without in 2014:

While this is no immediate threat to the existence of the cable business, companies like Comcast recognize the thin end of the wedge when they see it. Increasingly, they’ve become dependent on sports programming. Sports fans need to see sporting events live and won’t watch them via catch-up streaming services later. The thing is, the major sports leagues know how badly cable and satellite providers need their content, and they’ve used this market leverage to their advantage. In the NBA’s most recent cable TV deal, the cable stations committed to pay the league $2.6 billion annually. For comparison, in the previous 2007 deal, cable stations only had to pay $930 million. In effect, the NBA’s leverage over the cable networks has more than doubled in a 7-year period. In the short run, this means that cable networks get to continue to dominate sports coverage and will retain the subscriptions of millions of sports fans, but in the long run, this will drive up cable prices for consumers and push more of them into cutting the cord.

So if you’re Comcast, what do you do about all of this? How do you continue to increase revenue and profits in this changing world? There are really two choices:

1. Compete Better–cable providers could try to innovate and provide subscribers with better value for their services so that they are less likely to cut the cord. This is high risk. The cable companies may not ultimately be able to compete with streaming services. Streaming might just be better, and the cable companies may be on the wrong end of history.
2. Extort the Streaming Services–because cable providers are also internet providers, cable providers can threaten to slow down the connection speeds of internet users attempting to access streaming sites unless streaming companies give them truckloads of money. This will hurt the streaming services, forcing them to raise prices, which will make streaming less competitive and keep more people hooked on cable and satellite. This is risk free, and the cable company makes money either way–if consumers switch to streaming services, the streaming companies pay the fees the consumers used to pay, and if they don’t switch, the cable company continues to collect cable subscription fees directly from users.

If you’re a consumer, it’s pretty clear which one of these options is in your interest. If cable competes with streaming, the cable and streaming services will constantly be trying to outdo one another to win your business, improving your experience and lowering your costs. If however the cable companies extort the streaming services, you’ll either end up stuck with stagnant cable or stuck with unnecessarily expensive streaming costs. Indeed, the extortion option seems so heinous from the point of view of the consumer that the reader might even  be thinking, “surely that’s against the law, surely the cable companies can’t and won’t do that.” If you were thinking that, I have bad news for you–Comcast already did this to Netflix. Last winter, Comcast slowed down Netflix users’ download speeds until Netflix caved in and gave Comcast an undisclosed truckload of money:

Not to be outdone by Comcast, Verizon and AT&T began badgering Netflix for similar deals (you can even see Verizon tanking Netflix’s web speed in the chart above). Net neutrality prevents internet service providers from doing this by requiring them to treat all web destinations the same way–the provider is required to be neutral. If you’re a consumer, this is a great thing. It reduces your costs and forces companies to compete for your business.

So why does Ted Cruz have a problem with it? The thing about net neutrality is that to ensure that there’s fair competition between Comcast and Netflix, the state has to step in and regulate the market, banning providers from engaging in extortion. Ted Cruz is an ideologue–he thinks that all state regulations are necessarily pernicious, and that an unregulated market will naturally behave in a fair and equitable way. Net neutrality is a fantastic example of the limitations of this view. In the net neutrality case, the pro-market, pro-competition position is to regulate. To refuse to regulate is to enable internet service providers to use monopoly power to exploit the market, reducing its efficiency.

What Cruz doesn’t recognize is that markets can only function properly when supported by sound, well-conceived regulations. These regulations must necessarily extend beyond rote protection of property rights. In many cases in which business negotiate with each other (and when businesses negotiate with workers), there will be a profound imbalance in the negotiating power between the participants. Without regulations to check these power imbalances, weaker participants will be forced into accepting exploitative deals that harm not just themselves but the economic system as a whole.

This is not to say that all regulations are necessarily good. Whether a regulation is good or bad will depend on whether there is a malignant power imbalance that needs to be corrected, and whether the proposed regulation is an effective means of correcting that imbalance. It is just as foolish to support all regulations, regardless of their construction and purpose, as it is to oppose all regulations. Proposed regulations must be judged on their own merits. When it comes to net neutrality, the regulation Obama is proposing will successfully correct a serious power imbalance. It is a good regulation, and it should be adopted by the FCC.