The Independent Market Observer

Ways to Think About Net Neutrality

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Mar 2, 2015 11:01:00 AM

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net neutralityThe issue of “net neutrality” falls into the “boring but important” category that most of us normally ignore. Along with solar energy subsidies, social security wage bases, and other recondite things, it’s not visible every day but, nevertheless, does and will affect our lives.

I don’t want to take a position on this in particular—not because I don’t have one but because there are good and valid arguments for both sides. There is no right or wrong answer here, just a series of trade-offs. Where you come down has as much to do with values and how you look to the future as it does with the present day.

With that said, for those who aren’t fully up to speed on this, here are some ways to think about net neutrality.

What exactly is net neutrality?

First, let’s define what we’re talking about. Net neutrality, at its simplest, means all traffic is treated equally. That is, a movie on Netflix gets exactly the same priority as a transfer of a medical x-ray, a song download, or an e-mail of cat photos. Neutrality means just that. You can compare it to the way the highway system operates in most of the country—cars, trucks, and ambulances all use the same roads under the same rules. Simple and, on the face of it, fair.

Fairness is important. If companies can pick and choose who has access to customers, then they can control pricing and limit innovation. Would Netflix even exist if the cable channels had been able to lean on the cable companies to shut it down? Keeping companies out of the business of controlling what people can see doesn’t sound like a crazy idea to me.

Who should pay?

The conflict arises when companies that build the Internet infrastructure—the cables and routers that make it work—want to charge some users more. Limiting access is bad; charging more may not be. Netflix movies, for example, are large files that take up a lot of space to transmit. The cable companies want to reflect that extra usage by either charging Netflix more or being allowed to slow down those transfers to a level more proportionate with other usage. 

This isn’t a crazy proposition either. Consider a town with an electric power plant and an aluminum factory. Whenever the factory is working, it draws so much power that the rest of the town (houses, stores, hospitals, etc.) has brownouts. The utility needs to spend money to upgrade its power plant. Who should pay? The aluminum company would argue it should pay the same as everyone else, even though its high usage level is driving the need for the improved power plant. The homeowners might feel differently. 

Or, consider the highway system. A 20,000-pound truck does more wear to the roads than a 2,000-pound subcompact does. Should they pay the same? In fact, on toll roads, they usually do not. Trucks pay more because they impose more of a burden on the road. You might argue, based on this, that of course companies like Netflix should pay more.

What’s the problem?

Both the electric company and the road system are publicly owned or heavily regulated. There’s been very little advancement in either for decades because of a lack of investment, driven by the fact that there would be little return on that investment. Lower charges do, in fact, tend to limit innovation.

If we turn Internet services into that kind of regulated utility, the fear is that the same thing would happen. What we have here in the U.S. is already behind much of the rest of the world. Capping usage charges might well lock that disadvantage in place. Consider this:

  • Why, for example, should a company bother to build out a more advanced network if it can’t charge for it?
  • Why should Verizon’s shareholders suffer so people can watch Netflix faster?
  • Hasn’t charging more for higher usage worked well for the roads?

So, what’s the problem? The answer isn’t clear because there are two economic issues here: monopoly power and use-based pricing. They intersect in interesting ways. Later this week, I’ll talk some more about this and highlight some other areas where we are facing the same issue.

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