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POLICY INSTITUTE | POLICY BRIEF 1 The Best Path Forward on Net Neutrality BY ROBERT LITAN AND HAL SINGER SEPTEMBER 2014 Introduction Net neutralityÑthe notion that all Internet traffic, regardless of its source or type, must be treated the same by Internet Service Providers (ISPs)Ñis back on the na-tionÕs political radar. The catalyst was the D.C. Court of AppealsÕ decision last January PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 2 Unfortunately, the debate between the two sides has taken on the character of a religious dispute, with the FCC caught in the crossfire. The key to a possible reso-lution, however, may be the eventual realization by the Commission that Title II regulation of Internet access would (1) reduce ISP investment at the ÒcoreÓ of the Internet by more than what it stimulated at the ÒedgeÓ by content providers, re-sulting in a net loss in investment, and (2) could one day boomerang on certain major tech companies or be expanded to regulate other ISP offerings. In that case, the FCC will need another way to move forward on net neutralityÑand we pro-pose one in this report. So Which Way Forward? Focus on Investment The ÒInternet ecosystemÓ can be thought of as being populated by two types of players: ÒedgeÓ providers, who supply the content, devices and apps that arguably drive broadband subscriptions, and ÒcoreÓ providers, who build the infrastructure over which these apps operate. Investment by both types is critical to a properly functioning Internet ecosystem, and due to feedback effects, investment by one depends on the investment by the other. trepreneurs eventually give up. And knowing of their struggles, the next generation of would-be online entrepreneurs doesnÕt even bother trying. The Internet loses the experimentation that has long been its hallmark. On the other side, advocates give priority to investment at the core of the broa of invest-ment at the edge and the core. In the spiri PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 4 The figure below shows two possible reactions to a change in Internet regulation by core and edge providers. In both graphs, the vertical axis is the amount of investment and the horizontal axis is the amount of regulation. The red curve depicts edge investment as a func-tion of regulation (more is better), and the blue curve depicts core investment as a function of regulation (less is better). The black curve depicts the sum total of core and edge investment for any level of regulation. The graph in the left pane depicts a world in which both edge and core investment is sensitive to the amount of regulation, but edge investment is more so. Accord-ing to this worldview, edge providers should be analogized to orchids, extremely sensitive to their operating environments. Thus, while core investment slowly de-clines with more FCC oversight, edge investment drops dramatically as regulation is withdrawn. In this world, the optimal regulation of ISPs is a heavy-handed a PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 5 Imposition of Title II Regulations on Investment of CLECs One good historical example of Title II regulation that received scholarly attention is the mandatory unbundling of local exchange carriersÕ telephone networks re-quired by the Telecommunications Act of 1996. The results underscore that Title II regulation deters investment at the core. By relying on simplistic models that incorporate investment in backbone infrastructure that was not subject to Title II regulations, some commenters in the FCCÕs net neutrality proceeding draw the wrong inferences about the impact of the mandatory-sharing obligation on core investment.4 The purpose of this section is to set the record straight. The 1996 Act required the incumbent Regional Bell Operating Companies (RBOCs)Ñthe localized telephone monopolies that were part of the integrated PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 6 Removal of Title II Regulations on Cable Investment Although it may not have been clear when the 1996 Telecommunications Act was passed, cable television operators were best positioned to challenge the telcosÕ hegemony in voice services. But to enter this market, the cable operators first had to upgrade their networks to support Internet protocol (IP)-based transmissions, including voice over IP. Yet cable companies were reluctant to make such invest-ments so long as regulators were providing a less expensive entry path to a fa-vored constituency (the CLECs). High margins in local telephony and Internet access were the signal for new entrants, but the FCCÕs unbundling experiment was injecting unnecessary noise.It took a series of court orders and the unraveling of CLEC business plans based on UNEs beginning in 1999 for the cable operators to see the market signal through the noise. To gauge the effect of the unbundling rules on cable operators, one may compare cable investment from the three years following the 1996 Act (or what we call the Òwind-upÓ) to the three years beginning in 2000 (or what we call the Òwind-downÓ). Although it does not change the results, we omit 1999 from the comparison, because that year arguably was a transition period. According to the National Cable and Telecommunications Association, the average annual cap-ital expenditure for cable operators during the ÒwindupÓ was $6 billion (the av-erage of $5.7, $6.8, and $5.6 billion). In comparison, the average annual capital expenditure for cable operators during the Òwind-downÓ was $15.1 billion (the average of $14.6, $16.1, and $14.5 billion), an increase of 149 percent. PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 7 tions accounted for 61 percent of all U.S. residential connections capable of providing at least 3 mbps downstream and 768 kbps upstream. PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 8 and cableÑhave stayed within a fairly tight band ($64 to $70 billion annually) facing offerings by ISPs; once a regu-lated rate is established, a new proceeding would be needed to adjust it. Because Title II would limit the FCCÕs flexibility in the face of such uncertainty over in-vestment responses, the better approach in our view is starting with anti-discrimination enforcement under Section 706. Under this approach, both core and edge providers would be asked to make a modest sacrifice in exchange for the greater good. Barring the unlikely event in which the left panel of our graph de-picts reality, total investment would be maximized, and the regulatorÕs flexibility to adjust the rules in response to investment reactions would be preserved. Title II Could Boomerang on Tech Companies Title II was included in the original Telecommunications Act of 1934 to address potential problems created by having one company, the ÒoldÓ AT&T, being the monopoly p PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 9 the chance. Once unleashed on the Internet, Title II could be used by future Commissions to regulate other Internet services, including services not offered by ISPs. More specifically, application of Title II to Internet access could lay the founda-tion for imposing Title II regulation on some parties within the tech industry as well, an outcome that the firms operating at the edge of the network might not have expected but they should begin to worry about if they have not. This pro-spect also illustrates that the long-run interests of public interest and consumer advocates, on the one hand, and certain tech companies, on the other, are not as aligned as some might think. Reclassifying Internet access as a Òtelecommunications serviceÓ under Title II, as supplemented by the provisions of the Telecommunications Act of 1996, opens up the possibility that other tech services meet the same test. The clearest example would be GoogleÕs ultra-fast broadband service, Google Fiber, which the company is gradually rolling out. But it does not stop there. There is a very slippery slope from subjecting ISPs as common carriers to including other forms of Internet transmissions, because they arguably use Òtelecommunications services,Ó the legal hook in Title II for its application. For example, why not then include within the ambit of a telecommunications ser-vice the linkage to an advertiserÕs website that Google or Microsoft provide for users of their search engines? By clicking on links, the search engine uses the In-ternet backbone; if Internet access is a Òtelecommunications service,Ó because it provides Òtransmissions,Ó then so, too, are the search engines. The same logic po-tentially applies to AmazonÕs Kindle book reader device and service, because its owners are able to download books from Amazon, but only because they are con-nected to a wireless provider of Internet access in the process. Indeed, what would stop the FCC from classifying as Title II common carriers all device makers that have a connection to an ISP? In theory, the FCC could decline to take any one of all of these stepsÑfor now. But what happens down the road if public interest and/or consumer advocates decide they want the FCC to impose non-discrimination requirements on any or all of these tech providers? Google, for example, was investigated for several years by the FTC for allegedly discriminating against certain websites in its search results. The FTC pursued the investigation under its broad mandate under Section 5 of the Federal Trade Commission Act to prevent deceptive practices, but ultimately decided against bringing a case (although the competition authorities in the Eu-ropean Union had different ideas, ultimately forcing a settlement with Google which is still being contested). If GoogleÕs search activities, or those of any of the companies just mentioned, were subjected to Title II, then any of them could face discrimination complaints in the future under PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 10 either from competitors or the public interest/consumer advocacy communities. Even if the Commission did not extend Title II to these activities, the same groups could petition the agency, or seek a ruling from the courts, that it must do so on the ground that if transmitting packets across the Internet is a telecommunica-tions service, then so are these additional activities. Sound far-fetched? Maybe to some, but we have been around Washington long enough to know that laws or regulations implemented for one purpose are often used at a different time to justify extensions into other realms. The best example is the open-ended definition of pollution in Section 111(d) the Clean Air Act, writ-ten over 40 years ago, that is now being used by the Environmental Protection Agency (EPA) to regulate greenhouse gases (after the EPA in 2009 used that pro-vision to define carbon dioxide as a pollutant). Those in the tech community, and within the FCC itself, m PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 11 As for paid prioritization, Title II reclassification may not prohibit it: Even if the FCC agrees to impose non-discrimination requirements and other forms of com-mon carrier regulation on ISPs, Title II reclassification would not necessarily ban paid prioritization. As former enforcement director at the FTC, David Balto, has PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 12 FCC would move quickly to squash such conduct under regime, including our light-touch approach: At that point, the hypothetical offering can no longer be characterized as priority delivery; it is closer to blackmail. Rather than fixating on the prospect of Òfast lanes,Ó which exudes a covet-thy-neighbor ethic, net neutrali-ty supporters should be more concerned about the development of Òslow lanes,Ó which properly focuses on absolute (and not relative) utility. And slow lanes can be policed via case-by-case enforcement. Will Disputes Be Too Hard to Enforce? Enforcement of any case-by-case regime is laborious: it involves discovery and sometimes expert testimony. Decisions by administrative judges can be appealed to the full Commission, and even those decisions can be appealed to the D.C. Cir-cuit. In comments that received significant press attention, Major League Basball argued that ÒAs the nationÕs largest edge provider of live event video, we fail to see how the proposed regulatory scheme could provide the type of timely en-forcement that would be needed to adequately protect against such harms.Ó12 The best predictor of the FCCÕs ability to adjudicate complaints is to look at the agencyÕs performance in the video industry. There, the FCC has been called upon to adjudicate carriage disputes from independent cable networks, including NFL Network, Tennis Channel, MASN, WealthTV, and Game Show Network. In each case, after its Media Bureau deemed the complaint to be meritorious (assuming the claims were true), the FCC assigned the matter to an administrative law judge, who expeditiously conducted a hearing. Two cases settled (NFL Network and PROGRESSIVE POLICY INSTITUTE | POLICY BRIEF 13 Endnotes 1 FCC, Protecting and Promoting the "Commissioner PaiÕs Principles", July 31, 2014, http://sites.duke.edu/marx/2012/07/31/pai-principles/. 8 Robert C. Atkinson, Ivy E. Schultz, "Broadband in Ameirca: Where It Is and Where It Is Going", Columbia Institute for TeleInformation, November 11, 2009, http://www.broadband.gov/docs/Broadband_in_America.pdf. 9 USTelecom, "Broadband Investment",