1. Column: Net neutrality’s regulatory tightrope

Column: Net neutrality’s regulatory tightrope

Much of telecom pricing is based on price discrimination. So, the grounds to discourage it have to be compelling

Updated: April 15, 2015 12:05 PM

In the US, President Barack Obama’s recent statement, urging the Federal Communications Commission (FCC) to issue regulations embracing principles of “net neutrality” (NN)—seen by some as the gold standard for supervising internet traffic—created quite a stir and inevitably had cross-border effects, including in India. A series of articles appeared in the local media, both supporting and opposing NN, depending on whether the authors were pro-innovation or pro-investment. The argument is that NN encourages innovation but discourages operators to make infrastructure investments since they are unable to recover costs. Naturally, both sides present more nuanced arguments in their favour, although the main premise remains a trade-off between innovation and investment.

The outrage against Airtel’s proposal to begin charging customers more for making voice calls through apps like Skype and Viber than for regular browsing perhaps reflects the social bias in favour of NN, although it is not immediately clear how or in what form it will be implemented. We argue that NN is a principle that we in India should aspire for just as we should persuade the world’s largest search engine Google to support and implement unbiased presentation of results for queries submitted to it, also referred to as “search neutrality”.

First, the definition. One version of net neutrality is the idea that Internet Service Providers (ISPs) should offer users non-discriminatory access to all content without charging more for specific content at higher speeds. The phenomenal growth of content and applications such as Google, Facebook, WhatsApp, etc, would not have occurred in its absence. In this sense, NN allowed the internet to grow to the point where even temporary stoppages can be hugely disruptive. This implies that internet infrastructure, like other networks, produces ‘network effects’—meaning that the value of the economic activity the infrastructure supports expands simultaneously and, potentially, non-linearly. The social impact of additional investment may be higher once a threshold or critical mass is reached. For example, research has shown that Indian states that achieved a penetration rate of 25% or more in mobile telecommunications experienced significantly higher growth impacts compared to states that were below the threshold, i.e., the impact of telecommunications on growth is amplified by network effects. These characteristics have important implications for the manner in which internet infrastructure should be provided. To the extent that specific infrastructure activities entail economies of scale or depend on a monopoly network, they will not be efficiently provided in an unfettered market. It is useful to remember that the misallocation of resources under monopoly is a price too high and an output too low. Indeed, it was the exercise of monopoly power by ISPs like Verizon, Comcast and AT&T in the US that led to Obama’s statement in favour of NN. The contention is that you should not have to pay any more for choosing to use a service or website. other than the normal access charge. In the US, large parts of the internet service market constitute virtual monopolies—addressable markets are geographically divided between providers with competition at the local level often severely constrained. As a result, regulatory imposition of NN in the US could be seen as an instrument to prevent exploitation of consumers who end up at the mercy of the ISP that connects them to the content provider.

Is NN something worth defending? NN implies pretty much losing the ability to discriminate on the basis of prices. Price discrimination is the practice of selling at prices disproportionate to the marginal cost of production. Even if the products are different (in this case high-speed and low-speed access), it is still price discrimination in the wider sense in case the mark up on costs is different for the two product types. To draw an oft-repeated analogy, of dealing with congested roads in a city, price discrimination enables users to self select themselves into using a toll road. Those willing to pay choose to use it, although it does raise concerns of inequity in public spaces. But charging a higher price for high bandwidth would be difficult if not impossible under NN. One could for example charge higher for access during peak hours for all customers, but its legitimacy under NN would have to be determined by regulation. During the days of dominance of fixed networks, Ramsey pricing, a form of price discrimination, was used often for cost recovery-users who used the network more (say, during the day) were charged higher to defray network costs.

Much of internet and, indeed, telecommunications pricing in India and across the world today is built on price discrimination, so the grounds for regulators to discourage or even eliminate price discrimination must be compelling.

Is there a sound economic basis for imposing pricing prohibitions or, in other words, imposing NN? There is no simple answer to this question and that’s the rare art of regulatory decision-making. There is no doubt that internet has acquired characteristics of what economists call a public good with widespread positive spillover effects. In the US, the internet has often been equated with the highway system, an asset for the public good and not a product for private gain. We also know that independent regulation is primarily put in place for public or consumer interest. Thus, a large share of regulatory ‘art’ in this case will be to determine the impact on  social welfare—will accepting and allowing price discrimination serve the interests of a few profit maximising service providers while harming users of the internet and reducing overall welfare?

Once the maths is done, our guess is that one will also have to evaluate the local context—the extent of competition in and for the internet market (i.e. contestability), impact of social pressures on service providers (as in Airtel’s case) and whether the choice in favour of NN represents an embrace of some deeper values for India in the league of internet nations. All regulatory decisions are tough, but this one will be particularly hard because of the sharp and powerful divide between the two sides of the Internet market—developments in the access provision market can materially impact competition amongst content providers online (and vice versa, i.e., it is a two-sided market). It is good that the

Telecom Regulatory Authority of India has announced its intent to begin the process of public consultation on NN—we believe it’s not a moment too soon. It might also be useful to keep in mind Portia’s assertion in the Merchant of Venice: “If to do were as easy as to know what were good to do, chapels had been churches and poor men’s cottages princes’ palaces.”

By Rajat Kathuria, Mansi Kedia & Parnil Urdhwareshe
Kathuria is director and chief executive, Kedia is research associate and Urdhwareshe is a research assistant, ICRIER. Views are personal

Nilesh Basu Roy, research intern, ICRIER, contributed to the article

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