The Internet and Innovation: My Testimony to Congress

A couple days ago I had the privilege and pleasure to testify before the House Sub-committee on Communications, Technology and the Internet, which is part of the Committee on Energy and Commerce in the House of Representatives.

Broadly speaking, the topic was net neutrality. That is what the newspapers said.

Frankly, I hesitated to testify. I am always happy to talk with any government analyst who calls, irrespective of party affiliation. Congressional testimony is different, however, especially in this topic, which tends to yield more heat than light. Moreover, I am neither advocate nor opponent for net neutrality — at least as that phrase commonly gets used in US political debate. Why should I be a neutral voice in someone else’s political fight?

Ah, but I could not say no. Even with reservations, there still exists a professional obligation to show up. It is the right thing to do. Also, and I will admit to this, I was excited.

One other thing made it easy. The hearing did not concern the entire net neutrality debate. It concerned a rather specific question, something called House Resolution 37, which disapproves of the Open Internet Access Order issued by the FCC last December. If passed, the entire order would not take effect — not its provisions for transparency, blocking and discriminatory traffic.

I had testified at the FCC hearings leading up to to the order, and  had testified in favor of transparency provisions, for example. That made it easy. Such a blanket resolution — getting rid of everything — looked like throwing out the baby with the bath water. To me this resolution did not make sense.

One other broad motive shaped my views. I believe there actually is a big economic question on the table, and it gets lost in the popular debate. I hoped to bring attention to that. In a nutshell, if there is anything a government might be able to do, it might be able to foster economic growth by nurturing entrepreneurship on the Internet.

Those expectations were naive (of course), but we will get to that below. Anyway, that is why I agreed to come.

This post will share what I learned about how the existing political debate filters this topic.  Below is a copy of my oral testimony, and a link to my written testimony. After that comes many  observations about what sort of questions arose at the hearing. I hope others find this insightful and useful.

Testimony

Every witness is given five minutes to summarize their written testimony. As did others, I submitted an essay, which I wrote in a furious effort over three days. The five minutes summarized the written testimony. I can deliver six hundred words in about five minutes, so I wrote a summary of that length.

(If you want to hear everyone’s testimony, here is a c-span link for the entire hearing. My five minutes comes around minute 47. Be forewarned, the entire hearing takes several hours.)

Thank you for giving me an opportunity to speak. I am happy to share my views with you. Please understand, I do not work for anyone, neither firm nor advocate. I come as a professional economist who has had privilege to study and write about the commercial Internet access market, and almost since its inception.

From the standpoint of its economics, there are great potential risks from disposing of the Open Internet Access Order, and the gains from continuity are high.  The order looks like a good innovation policy and good economic policy.

If we want to create a prosperous commercial Internet in the next fifteen years, think about how well the Internet works today. Now think about all the ways that could have gone wrong. My advice boils down to: avoid the same problems we avoided in the past.

How to do that? Keep transactions costs low for entrepreneurs. The United States commercial Internet functions well today because it avoids a number of industry practices that would raise the transactions costs of innovation, that would introduce hassles, delays, and haggling. Instead, today any entrepreneur can enter without worrying about gaining the permission of any gateway firms.

If the US government commits to no regulatory intervention in Internet access markets would that invite problems? The experience of the last fifteen years suggests there is a risk it will and a chance it will not. It is hard to tell. Until recently, regulatory restraints prevented all carriers from taking certain actions, so there is little experience from which to forecast how carriers would behave in the absence of restraint.

One central concern arises due the commercial activities in one line of business – for example, broadband service – affecting the prospects in another – for example, telephony, or video entertainment. If carriers act on their economic incentives, we would expect carriers to help all their businesses, deliberately become less transparent to rivals, block some content of rivals, or give low priority to the traffic from erstwhile competitors. Concentrated supply of access in some locations of the United States also heightens the incentives to act this way.

A balanced view would also note that other factors push in the other direction. National standardization processes generate transparency. User tendencies to substitute to alternative carriers in some markets also reduce incentives to block traffic. Reasonable people can differ on the relative importance of these forces, and that is an additional reason why forecasting is hard to make.

The dangers would be costly. Any movement towards less transparency and more blocking and more discrimination of traffic introduces hassles and delays for entrepreneurs, software innovators, server companies around the globe, even juniors at Harvard with ambitions to unseat Mark Zuckerberg. Overall, taking away regulatory oversight risks the emergence of a very undesirable consequence, less commercial innovation and its child, less economic growth.

Policies that tend towards continuity are the most desirable. Continuity here is a regime of continued regulatory presence, with occasional and consistent action.

It is my view, as it is of many others, that the FCC’s policy represents continuity. Frankly, I think broadband firms can live with this rule because it really does not change much of what they do. Entrepreneurs can thrive under this rule, because it lets them innovate and start business as easily tomorrow as they did in the past, and raises the certainty that no additional hassles will emerge in the near term. Moreover, the rule includes important and appropriate exceptions – for reasonable network management and the complications of wireless applications.

In sum, the potential risks of disproving the rule are great, and the gains from continuity are high.  The order looks like a good innovation policy and good economic policy.

Thank you for your attention, and thank you for allowing me to testify.

Observations

The questions began after we all testified. I learned two broad lessons, some about substance and some about process. Let me start with substance.

First, some representatives did not filter this topic through any economic lens. Instead, the issues regarding the FCC’s legal and regulatory authority interested them. Mostly Republicans raised this issue. I could not tell if someone said this because they were looking for a convenient argument against the Order, or they actually wanted to go back to law school and have a broad principled debate. Democrats seemed to grow tired and irritated with this approach, especially when some Republicans made broad points that appeared to be unencumbered by the actual history of regulation in this market. At one point one of the representatives lectured the others — listing fifteen years of regulatory history in this topic, showing real irritation at the misstatements and oversimplifications from some of the Republicans.

Second, some representatives had principled opposition to using federal regulatory institutions for any purpose that shapes the Internet. Once again, I could not tell if someone said this because they were looking for a convenient argument against the Order, or they actually wanted to take a principled stand against all regulation, irrespective of the consequences. Once again, the Demos showed impatience with this stand. Virtually all commentators have said (correctly, in my view) that the Order does not really do very much or change very much for wireline firms, who serve far more than 90% of the homes who get Internet service in the US. So this looks like a principled stance against something that has few real economic consequences.

Third, one representative brought up a milder version of a similar argument, which actually is worthy of attention. One representative talked about “a nose in the tent.” Since that metaphor refers to camels, I think it would have been more precise to refer to a “foot in the door.” That is, there is a concern about the future expansion of action, not about the present action per se’. I actually understand this point in principle, albeit there is no evidence for it today, as the FCC has gone out of its way to make sure their action is interpreted as a restrained and mild action. Still, present governments cannot bind the actions of later government agencies, so this is a point worthy of consideration. It only has one big problem: to commit agencies to act a certain way Congress needs to pass new legislation, binding later agency action. However, everyone knows the present Congress is tied up in knots, so that will not happen.

Fourth, the Republicans tried to embody the three above arguments with the testimony of a Wireless ISP, a fixed supplier of data services in low density locations — sort of wifi on a tremendous number of steroids, if you want to think of it that way. Wireless ISPs play a valuable role in places that wireline firms cannot reach, but face cost and capacity issues, almost by definition. The blocking and discriminatory rules affect their business, and that gets my sympathy. It also gets sympathy from representatives that have rural areas in their district, which was the point of including them in this hearing. Unfortunately for the WISPs, however, they provide service for far less than 10% of households in the US, so a rational national policy would not bend the rules (much) for the entire country just to accommodate their peculiar problems. After all, the best forum for their issues is in a debate about universal service policy. (But who said this had to be a rational debate? Oh, never mind.)

Using a different line of reasoning, for some commentators — especially from the left — the open access order is not really about economics. Rather, it is about protecting unrestricted access to news and other channels of information. Removing regulation permits private firms to shape those channels without restraint, threatening the free flow of information, a dangerous situation for a democracy. I confess to having some sympathy for this remark too, as it has a long history in media studies. The newspapers in single newspaper towns show no tendency to be less biased, for example. It also has salience in this situation, especially as the Internet increasingly becomes the primary channel for information for the young, and the supply is concentrated in many parts of the US. (To be frank, we did not really debate this point in much detail. It did not seem to be the central issue on the minds of most of the representatives.)

Fifth, probably the most interesting moment for me came in the discussion about transparency, which is something I have researched in some detail. I think the bright light of scrutiny can do lots of good in this industry. One representative polled the entire panel and found that all of us thought the transparency requirements were a good idea, even those who supported the Republicans. I heard later that, despite agreement by the panel, no exception was made for transparency during the final write-up. That was rather strong evidence that many representatives did not intend to let anything at the hearing get in the way of their stance. I suspect that many Democrats found this stubbornness to be especially irritating.

Sixth, several Republicans tried to make the argument that the rules represented a transfer of wealth from broadband firms to content firms, such as Google. As sensible economics comes and goes, this argument cannot hold water. First, users buy a service and ISPs deliver it, and ISPs have managed (as an industry) to handle fifteen years of growth in demand for data. Most analysts have correctly pointed out that the rules make almost no difference to the business of these firms, so it just seems like a stretch, at best. Second, wireline firms in the US are healthy, and make sufficient revenue to pay for capital upgrades to their capacity. On top of that, the costs of data are just not the biggest costs for most ISPs, even with Netflix. If these costs become a crisis we will know it as a country, but I just do not expect they will become one. Third, this argument is comparable to the owner of a well run and well funded high speed highway complaining that they cannot put up a tool booth next to exit to the shopping mall. Certainly the owner of the highway would make more money with a tollbooth than without, and the largest store in the mall would survive if it was Walmart. Yet, if the highway/broadband already runs well (it does) and Walmart/Google already operates efficiently (it does), shouldn’t policy be more worried about the effect of the tool booth on all the small stores with marginal economics who provide the competition to Walmart? Maybe one day one of them will grow into something bigger and be a direct competitor to Walmart — how will that happen unless we let them grow now?

Finally, a number of representatives tried to compare Comcast’s behavior to Google’s, as part of some broad point about removing regulation from Facebook and Google and, while we are at it, Verizon and Comcast. While I did not entirely understand why anybody would have thought this was persuasive, the point went something like this: They are both big commercial firms, but one is covered by the Order and the other is not, and this is unfair. I confess that I was so hoping someone would ask me about this question (nobody did), because it is such an awkward comparison.  Google makes money because they invented a whole new market, innovated like a great entrepreneurial firm, and they continue to do so. Wireline broadband firms make money because they invested capital to develop a new service, and got regulatory rules put in place so the only competitors are inter-modal competitors, namely, wireless providers. The wireline broadband business is healthy, and not going anywhere. Moreover, while Google is healthy, they are scared. Yes, scared. Because Google lives in the midst of the most Schumpeterian part of the Internet economy, they are scared of Facebook and Yelp and others, who are starting to take advertising away from them. Imagine that! A firm that did not even exist six years ago is threatening Google because of the open Internet. No such Schumpeterian competition is imaginable in the wireline Internet. If anything, Google shows off the best part of the US Schumpeterian economy, and wireline ISPs do not. Shouldn’t policy focus on preserving the good parts, and making sure nothing interferes with it?

Process

Now let’s talk about the process.

First, the hearing was primarily political theater, perhaps exclusively so. Nothing said at this hearing appeared to shape any short run outcome on the Republican side. The Republican majority already had a majority of votes to pass the resolution in the subcommittee. Nobody expects the president to sign it, even if the resolution passes the Senate, which is not expected. Nothing said in the meeting would have changed the vote. I completely understood that later, and saw hints of it as the hearing went on. Many representatives used the hearing to ask leading questions that justified their positions. They were not really interested in the answers.

Second and related: If the vote was preordained, what was the point of the hearing? Three possibilities. First, holding the hearing meets somebody’s sense of fairness. This must matter. The Chairman of the committee, who is a Republican, referred to some previous sore points about process when the Dems were in charge. Second, though some Democrats dislike net neutrality, the hearing might have been designed to remind those who were wavering. In other words, the hearing actually might have been more about an argument between Democrats than between Democrats and Republicans. Third, as best as I could tell, this hearing also was designed to generate headlines and articles and impressions for the insiders who thrive on following this sort of thing — namely, this is political theater for its own sake.

Third, and more subtle: Some of the representatives paid attention. I do mean that about representatives on both sides (though in order not to embarrass those who were not really paying attention, I will not make any remarks about who showed up most of the time and who paid attention and who did not). Some of them listened to the discussion, and it showed in their questions. It was one of those things that insiders must see day in and day out. Look, even though I did not agree with some of them, it was great to see a robust discussion.

Fourth, I was extremely impressed with the staff who worked behind the scenes. I had extended conversations with one staff member before the hearing, who was extremely sharp. Once I got there I had several conversations with others from all sides (including a Northwestern Alum), and they too were very sharp. Why does it matter? Because the quality of government depends on more than the quality of its representatives. It also depends on the quality of those who do all the staff work, and it really depends on all sides being sharp, doing their homework, focusing on the issues, listening to reasoned debate, and fashioning policy to suit reasonable points. More than any other impression, this one left me with more faith in my government than when I had arrived.

Fifth, many academics would be disappointed with this hearing, or, perhaps, would have the wrong expectation about the role economic analysis plays in these debates. Some representatives asked some good economic questions, but they purposefully did not ask me those questions. While I do not have an inflated view of my expertise, I sure do know a lot about how the Internet works, how the business works, how the economics works, and why it works the way it works. I have been doing this for fifteen years, after all. However, I had been invited by one side and not the other, so there was no such thing as neutrality in that hearing room, even if I think of myself as neutral. Moreover, this was not an economic seminar. Educating the representatives and the public about economic matters was far from the primary goal of the hearing. The academy’s goals are not the goals of the political sphere, and never will be. That is that.

What would James Tobin have said?

The entire hearing reminded me of a remark I heard at my college graduation. James Tobin, the Noble Prize winning economist from Yale, spoke. He had a well known wit and it was on display that day. For some reason his speech resonated with me. I am paraphrasing the remark from his speech (it was a while ago and I did not take notes). He observed that everyone in the US is an economist, and quite willing to engage in economic argument, even with Tobin himself, and in spite of his own credentials. He observed that this was a strength of the US, even though, he noted dryly, it occasionally led to passionate discussions on trains with strangers who were unlikley to change his views.

I think I now appreciate that observation in a different way. Every representative in the hearing debated economics. Frankly, the representatives put on an impressive display of understanding and misunderstanding of the basic economics of the Internet, applying and misapplying economic metaphor in more ways than I could have possibly imagined. The fact that they were debating it at all seems, however, to be the bigger point. It is great to live in a democracy where such matters can be debated.

As for the substantive lesson of the hearing, it focused my attention on a long standing and open question in Internet economics: what is the best way for policy to encourage entrepreneurship in the Internet? As it was, the hearing did encapsulate two views about how to avoid discouraging economic growth. Oversimplifying, one camp views regulatory intervention as dangerous, potentially leading to the Gordian knots that grow up around regulatory processes. For others, including me, an unrestrained carrier represents the biggest immediate danger, introducing the potential for encumbering hassles and transactions costs, just as gateway firms impose on entrepreneurs.  

We did not settle any of this in our few hours, nor could we have. These are the sort of debates that never settle.

Was I sorry I agreed to testify? Not even a whiff of regret. It was a thrill to take part. If asked, I would certainly do it again.

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Late addition: Robin Chase, one of the others who testified, has written a set of musing about her experience testifying. Here is a link. It is great. Take a look!