Pai’s Right on Net Neutrality and Title II

Thom Lambert —  29 November 2017 — Leave a comment

As I explain in my new book, How to Regulate, sound regulation requires thinking like a doctor.  When addressing some “disease” that reduces social welfare, policymakers should catalog the available “remedies” for the problem, consider the implementation difficulties and “side effects” of each, and select the remedy that offers the greatest net benefit.

If we followed that approach in deciding what to do about the way Internet Service Providers (ISPs) manage traffic on their networks, we would conclude that FCC Chairman Ajit Pai is exactly right:  The FCC should reverse its order classifying ISPs as common carriers (Title II classification) and leave matters of non-neutral network management to antitrust, the residual regulator of practices that may injure competition.

Let’s walk through the analysis.

Diagnose the Disease.  The primary concern of net neutrality advocates is that ISPs will block some Internet content or will slow or degrade transmission from content providers who do not pay for a “fast lane.”  Of course, if an ISP’s non-neutral network management impairs the user experience, it will lose business; the vast majority of Americans have access to multiple ISPs, and competition is growing by the day, particularly as mobile broadband expands.

But an ISP might still play favorites, despite the threat of losing some subscribers, if it has a relationship with content providers.  Comcast, for example, could opt to speed up content from HULU, which streams programming of Comcast’s NBC subsidiary, or might slow down content from Netflix, whose streaming video competes with Comcast’s own cable programming.  Comcast’s losses in the distribution market (from angry consumers switching ISPs) might be less than its gains in the content market (from reducing competition there).

It seems, then, that the “disease” that might warrant a regulatory fix is an anticompetitive vertical restraint of trade: a business practice in one market (distribution) that could restrain trade in another market (content production) and thereby reduce overall output in that market.

Catalog the Available Remedies.  The statutory landscape provides at least three potential remedies for this disease.

The simplest approach would be to leave the matter to antitrust, which applies in the absence of more focused regulation.  In recent decades, courts have revised the standards governing vertical restraints of trade so that antitrust, which used to treat such restraints in a ham-fisted fashion, now does a pretty good job separating pro-consumer restraints from anti-consumer ones.

A second legally available approach would be to craft narrowly tailored rules precluding ISPs from blocking, degrading, or favoring particular Internet content.  The U.S. Court of Appeals for the D.C. Circuit held that Section 706 of the 1996 Telecommunications Act empowered the FCC to adopt targeted net neutrality rules, even if ISPs are not classified as common carriers.  The court insisted the that rules not treat ISPs as common carriers (if they are not officially classified as such), but it provided a road map for tailored net neutrality rules. The FCC pursued this targeted, rules-based approach until President Obama pushed for a third approach.

In November 2014, reeling from a shellacking in the  midterm elections and hoping to shore up his base, President Obama posted a video calling on the Commission to assure net neutrality by reclassifying ISPs as common carriers.  Such reclassification would subject ISPs to Title II of the 1934 Communications Act, giving the FCC broad power to assure that their business practices are “just and reasonable.”  Prodded by the President, the nominally independent commissioners abandoned their targeted, rules-based approach and voted to regulate ISPs like utilities.  They then used their enhanced regulatory authority to impose rules forbidding the blocking, throttling, or paid prioritization of Internet content.

Assess the Remedies’ Limitations, Implementation Difficulties, and Side Effects.   The three legally available remedies — antitrust, tailored rules under Section 706, and broad oversight under Title II — offer different pros and cons, as I explained in How to Regulate:

The choice between antitrust and direct regulation generally (under either Section 706 or Title II) involves a tradeoff between flexibility and determinacy. Antitrust is flexible but somewhat indeterminate; it would condemn non-neutral network management practices that are likely to injure consumers, but it would permit such practices if they would lower costs, improve quality, or otherwise enhance consumer welfare. The direct regulatory approaches are rigid but clearer; they declare all instances of non-neutral network management to be illegal per se.

Determinacy and flexibility influence decision and error costs.  Because they are more determinate, ex ante rules should impose lower decision costs than would antitrust. But direct regulation’s inflexibility—automatic condemnation, no questions asked—will generate higher error costs. That’s because non-neutral network management is often good for end users. For example, speeding up the transmission of content for which delivery lags are particularly detrimental to the end-user experience (e.g., an Internet telephone call, streaming video) at the expense of content that is less lag-sensitive (e.g., digital photographs downloaded from a photo-sharing website) can create a net consumer benefit and should probably be allowed. A per se rule against non-neutral network management would therefore err fairly frequently. Antitrust’s flexible approach, informed by a century of economic learning on the output effects of contractual restraints between vertically related firms (like content producers and distributors), would probably generate lower error costs.

Although both antitrust and direct regulation offer advantages vis-à-vis each other, this isn’t simply a wash. The error cost advantage antitrust holds over direct regulation likely swamps direct regulation’s decision cost advantage. Extensive experience with vertical restraints on distribution have shown that they are usually good for consumers. For that reason, antitrust courts in recent decades have discarded their old per se rules against such practices—rules that resemble the FCC’s direct regulatory approach—in favor of structured rules of reason that assess liability based on specific features of the market and restraint at issue. While these rules of reason (standards, really) may be less determinate than the old, error-prone per se rules, they are not indeterminate. By relying on past precedents and the overarching principle that legality turns on consumer welfare effects, business planners and adjudicators ought to be able to determine fairly easily whether a non-neutral network management practice passes muster. Indeed, the fact that the FCC has uncovered only four instances of anticompetitive network management over the commercial Internet’s entire history—a period in which antitrust, but not direct regulation, has governed ISPs—suggests that business planners are capable of determining what behavior is off-limits. Direct regulation’s per se rule against non-neutral network management is thus likely to add error costs that exceed any reduction in decision costs. It is probably not the remedy that would be selected under this book’s recommended approach.

In any event, direct regulation under Title II, the currently prevailing approach, is certainly not the optimal way to address potentially anticompetitive instances of non-neutral network management by ISPs. Whereas any ex ante   regulation of network management will confront the familiar knowledge problem, opting for direct regulation under Title II, rather than the more cabined approach under Section 706, adds adverse public choice concerns to the mix.

As explained earlier, reclassifying ISPs to bring them under Title II empowers the FCC to scrutinize the “justice” and “reasonableness” of nearly every aspect of every arrangement between content providers, ISPs, and consumers. Granted, the current commissioners have pledged not to exercise their Title II authority beyond mandating network neutrality, but public choice insights would suggest that this promised forbearance is unlikely to endure. FCC officials, who remain self-interest maximizers even when acting in their official capacities, benefit from expanding their regulatory turf; they gain increased power and prestige, larger budgets to manage, a greater ability to “make or break” businesses, and thus more opportunity to take actions that may enhance their future career opportunities. They will therefore face constant temptation to exercise the Title II authority that they have committed, as of now, to leave fallow. Regulated businesses, knowing that FCC decisions are key to their success, will expend significant resources lobbying for outcomes that benefit them or impair their rivals. If they don’t get what they want because of the commissioners’ voluntary forbearance, they may bring legal challenges asserting that the Commission has failed to assure just and reasonable practices as Title II demands. Many of the decisions at issue will involve the familiar “concentrated benefits/diffused costs” dynamic that tends to result in underrepresentation by those who are adversely affected by a contemplated decision. Taken together, these considerations make it unlikely that the current commissioners’ promised restraint will endure. Reclassification of ISPs so that they are subject to Title II regulation will probably lead to additional constraints on edge providers and ISPs.

It seems, then, that mandating net neutrality under Title II of the 1934 Communications Act is the least desirable of the three statutorily available approaches to addressing anticompetitive network management practices. The Title II approach combines the inflexibility and ensuing error costs of the Section 706 direct regulation approach with the indeterminacy and higher decision costs of an antitrust approach. Indeed, the indeterminacy under Title II is significantly greater than that under antitrust because the “just and reasonable” requirements of the Communications Act, unlike antitrust’s reasonableness requirements (no unreasonable restraint of trade, no unreasonably exclusionary conduct) are not constrained by the consumer welfare principle. Whereas antitrust always protects consumers, not competitors, the FCC may well decide that business practices in the Internet space are unjust or unreasonable solely because they make things harder for the perpetrator’s rivals. Business planners are thus really “at sea” when it comes to assessing the legality of novel practices.

All this implies that Internet businesses regulated by Title II need to court the FCC’s favor, that FCC officials have more ability than ever to manipulate government power to private ends, that organized interest groups are well-poised to secure their preferences when the costs are great but widely dispersed, and that the regulators’ dictated outcomes—immune from market pressures reflecting consumers’ preferences—are less likely to maximize net social welfare. In opting for a Title II solution to what is essentially a market power problem, the powers that be gave short shrift to an antitrust approach, even though there was no natural monopoly justification for direct regulation. They paid little heed to the adverse consequences likely to result from rigid per se rules adopted under a highly discretionary (and politically manipulable) standard. They should have gone back to basics, assessing the disease to be remedied (market power), the full range of available remedies (including antitrust), and the potential side effects of each. In other words, they could’ve used this book.

How to Regulate‘s full discussion of net neutrality and Title II is here:  Net Neutrality Discussion in How to Regulate.

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

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