Many thanks to the Truth on the Market bloggers for having me. I’ve long enjoyed reading the blog and am delighted to be contributing. A quick disclaimer up front to apply to all my posts: The views expressed here are my own and do not express the views of my employer or clients.
Economists have long warned against price regulation in the context of network industries, but until now our tools have been limited to complex theoretical models. Last week, the heavens sent down a natural experiment so powerful that the theoretical models are blushing: In response to a new regulation preventing banks from charging debit-card swipe fees to merchants, Bank of America announced that it would charge its customers $5 a month for debit card purchases. And Chase and Wells Fargo are testing $3 monthly debit-card fees in certain markets. In case you haven’t been following the action, the basic details are here. What in the world does this development have to do with an “open” Internet? A lot, actually.
The D.C. Court of Appeals has been asked to consider several legal challenges to the FCC’s Open Internet Order. Passed in December 2010, the Open Internet Order was the regulatory culmination of an intense lobbying campaign by certain websites and so-called consumer groups to regulate the fees that Internet access providers such as Comcast or Verizon may charge to websites.
Although the challenges to the Open Internet Order largely concern the FCC’s authority to regulate Internet access providers and the proper scope of the regulations—for example, whether they should apply to wireline networks only or to all broadband networks including wireless—here’s to hoping that the rules are also judged according to the FCC’s public-interest standard. Along that dimension, the FCC’s experiment in price regulation clearly fails.
Just as Internet access providers bring together websites and users, banks provide a two-sided platform, bringing together merchants and customers in millions of cashless transactions. Because banking networks cost money to create, banks can’t be expected to provide their services for free. If you tell a bank that it can’t charge one side of a two-sided market—particularly when that one side (the merchant side) is less price sensitive than the other (the customer side)—then expect customer fees to rise. It’s not because banks are evil; it is because the profit-maximizing price charged to customers by a bank depends on the price charged to merchants.
Ignoring this economic lesson of two-sided markets, the Durbin Amendment to the Wall Street Reform and Consumer Protection Act instructed the Federal Reserve Board to cap swipe fees charged by banks to merchants. Prodded by consumer advocates to eliminate the fees entirely, the Fed cut the fees in half, to about 24 cents per transaction from an average of 44 cents per transaction. Paradoxically, the smaller the merchant fee, the larger is the debit fee—this is the “seesaw principle” of two-sided markets in action. Say hello to $5 monthly debit fees.
In a classic case of one regulation spawning another, now there is talk of regulating the banks’ debit-card charges. In response to the new debit fees, some members of Congress asked the Justice Department to investigate the major banks, suggesting that the higher fees resulted from a pricing conspiracy and not from their own bone-headed price regulation.
Months before the new debit fees came into effect, Bob Litan of the Brookings Institution predicted in a paper that “consumers and small business would face higher retail banking fees and lose valuable services as banks rationally seek to make up as much as they can for the debit interchange revenues they will lose under the [Federal Reserve] Board’s proposal.” As noted by Todd Zywicki in the Wall Street Journal, Litan’s prediction proved prescient.
Although both the Durbin Amendment and the FCC’s Open Internet Order are price regulations, there are important differences. Unlike the Fed’s rulemaking on swipe fees, the Open Internet Order was not directed by Congress. This shortcoming alone might be fatal for the Appeals Court. And unlike the Fed’s rulemaking, the FCC’s rulemaking regulates the merchant fee out of existence. Regulating prices below market-levels (as the Fed did) is one thing—regulating them to zero (as the FCC proposes) is beyond the pale.
Under the Open Internet Order, Internet access providers are banned from charging websites a surcharge for priority delivery. Indeed, the mere offering of such a fee to one website would be “discriminatory” and thus presumptively anticompetitive, even if the same offer were extended to other websites. Self-described public interest groups advocating for the Open Internet Order believe that if the smallest website in America can’t afford a surcharge for priority delivery, then no one should be allowed to buy it.
Assuming the FCC’s Order withstands legal scrutiny, the rules will clearly retard innovation among application developers: Why develop the next, killer real-time application if you can’t contract for priority delivery?
And if the Durbin Amendment is any guide, the effect of the Open Internet Order will be higher Internet access prices for consumers.
The same Bob Litan who accurately predicted price hikes in banking caused by price regulation made a similar prediction for broadband networks: “Even according to a theoretical model championed by net neutrality proponents, end users are unequivocally worse off under net neutrality regulation, as the end-user price of broadband access is always higher when ISPs are barred from raising revenues from content providers.” Will his sage advice be ignored by regulators twice in the same year?
The Appeals Court should force the FCC to defend the notion that the agency’s Open Internet Order is consistent with the public interest: If higher access prices and less innovation among application developers are the unintended consequences of an “open” Internet, then the FCC will fail on this score. With luck, the Open Internet Order will be seen as the ugly cousin of the Durbin Amendment, and the FCC’s experiment in price regulation will be curtailed.
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The service a bank provides to merchants and account holders is inconsistent with an analogy involving ISPs, their customers, and content providers.
Visa serves both merchants and account holders. Both groups are Visa’s customers. It seems appropriate to me that Visa can charge one or the other (or both) parties for the services it provides. If regulation prevented Visa from charging one, it would follow that Visa would compensate by increasing the charge to the other.
Comcast provides internet access to consumers, but does not serve a content provider like Netflix. Netflix has its own provider it pays for internet access. Why should Netflix (or any other app or content provider) pay Comcast (or any other ISP) for priority treatment? And how would such an arrangement benefit consumers? It seems that if content providers were forced to make deals with Comcast (to reach its captive consumers), that this arrangement would increase the content provider’s operating expenses, increase the barrier to entry into the market place, and increase the cost of the content provider’s service. Overall fail for the consumer, fail for content providers, win for Comcast and its monopoly in certain areas.
As the value of the internet increases, and increased availability, performance, and usage is expected, consumers should expect to see commensurate price increases. The FCC’s regulation ensures that these price increases are not the results of an arbitrary deal that ISP A made with content provider B and are instead based on fair and open access to the internet as a whole.
Blake, you have your analysis a little off, it is not Visa that you are a customer of, it is your bank. Your bank chose the Visa network, they could have also have chosen Mastercard. Visa does not know your account information, your bank does. Visa is just the link between the merchant and the bank that holds your money.
Think of it this way:
Merchant = website
Visa = internet backbone
bank = comcast
account holder = consumer
Take Netflix for example, their streaming movies are great until enough people start viewing them and then it will start bogging down comcast’s network. So, if you are comcast, you start getting complaints from other users that your network is slowing down and when you look, you see it is consumers accessing Netflix movies. So, you have 3 options…
1. slow the speed of streaming content used by heavy streamers to have a more balanced share for everyone else on the network (at certain payment levels, the amount of bandwidth capacity is shared to a certain number of users, if some use more, there is less for the others to use).
2. charge the streaming consumer more for their internet connection so they can have a bigger share (fewer users with the same capacity means they can use more at a time).
3. ask Netflix to pay for that portion for the extra bandwidth that comcast’s consumers are using.
As for debit cards, 1 has not been talked about (limiting the number of debit transactions a person could make in a given time). The Durbin amendment limited 3, merchants paying the bank. That leaves 2, banks charging account holders directly.
Sorry computer problems.
First, why do you assume fees will remain? Some people are leaving the banks that are charging fees. Even if the fees remain, there is competition taking place. It may not be the most efficient competition but it is in the open. No competition existed before when the fee was charged to merchants (so it seems irrelevant if competition could have existed).
Second, why do you assume free speech is must be cheap? I always thought our fundamental rights came with burdens and expenses. We’re just seeing them play out and get valued in the net neutrality debate. The FCC rules seem to implement a type of mandatory free speech on the private sector ISPs. A modern day common carrier for speech, if you will. As a late note, if you think app developers are less incentivized to make apps because of the FCC rules, you need more app developers friends. I know several CEOs of app and programming companies. All of them love the principles the app. Sure, on a theoretical level some form of competition might not exist anymore. But in the real world. There’s a hundred different forms of competition they have before even considering paying ISPs for priority delivery. Heck, if they paid for it hen it would almost be an admission that their app otherwise sucks because they have to pay for it to get priority treatment (research how google runs its network if you don’t get this aspect).
Two quick questions:
FIrst, why are you assuming bank fees will remaIn? Competition is taking place. Some people (like me) are leaving banks that decided to charge for banks that decided not to charge. Who kn