Economic Principles for a Sound Economic Principles for a Sound Internet Policy: The PrequelInternet Policy: The Prequel

ororWhat Would Alfred Marshall Say?What Would Alfred Marshall Say?

John W. MayoJohn W. MayoGeorgetown UniversityGeorgetown Universitymayoj@georgetown.edumayoj@georgetown.edu

(202) 687-6972(202) 687-6972

United States SenateFebruary 16, 2007

The Telecommunications Policy Debate in 2006: The Telecommunications Policy Debate in 2006: Loud Voices of the The ExtremistsLoud Voices of the The Extremists

““The telecommunications industry is really The telecommunications industry is really trying to destroy our Internet!”trying to destroy our Internet!”

““Telecommunications markets are perfectly Telecommunications markets are perfectly contestable… we can be confident that contestable… we can be confident that broadband competition will continue to broadband competition will continue to flourish and increase in the future.flourish and increase in the future.””

2007: A More Cerebral Approach?2007: A More Cerebral Approach?

“If we knew what we were doing, it wouldn’t be called research, would it?”

Albert Einstein

Today’s Policy Debate in PerspectiveToday’s Policy Debate in Perspective

Telecommunications Act of 1996 – Telecommunications Act of 1996 –

– ““To promote competition and reduce regulation in order to secure lower prices and higher quality services for American telecommunications consumers and encourage the rapid deployment of new telecommunications technologies.”

– “The FCC and states shall “encourage the deployment on a reasonable and timely basis of advanced telecommunications capability to all Americans … by utilizing, in a manner consistent with the public interest, convenience, and necessity, price cap regulation, regulatory forbearance, measures that promote competition in the local telecommunications market, or other regulating methods that remove barriers to infrastructure investment.”

A quick look: How are we A quick look: How are we doing?doing?

Broadband Deployment in the U.S.

0

10

20

30

40

50

60

70

2000 2001 2002 2003 2004 2005 2006

Millions of Households

BROADBAND DEPLOYMENT IN THE UNITED STATES

Source: FCC

High Speed Line Growth 1999-2005High Speed Line Growth 1999-2005

0

10

20

30

40

50

60

1999 2000 2001 2002 2003 2004 2005

Millions

Satellite and Wireless

Fiber

Cable Modem

SDSL and Traditional Wireline

ADSL

Source: FCC's High Speed Services for Internet Access Report, July 2006

Wireless Subscribers in the U.S.

0

50,000

100,000

150,000

200,000

250,000

1990199119921993199419951996199719981999200020012002200320042005

Thousands

Source: FCC

WIRELESS SUBCRIBERS IN THE UNITED STATES

Rates for Communications Services (1995 - 2005)Rates for Communications Services (1995 - 2005)

Source: FCC

Cable2005

$43.04

Cable

1995$22.37

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Year

Normalized Price

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%CableCPITelephone Services

Land-line InterstateLand-line IntrastateWirelessAvg Rev/Min Wireless

Cable Rates and the CPI, 1995-2005

Cable 1995$22.35

Cable2005

$43.04

0.80

1.00

1.20

1.40

1.60

1.80

2.00

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Year

Normalized Price

-20%

0%

20%

40%

60%

80%

100%

Cable Price (basic-plus-expanded basic)

CPI

Source: FCC (December 2006)

Cable Television Rates

Beyond Telecommunications: Beyond Telecommunications: What’s at Stake?What’s at Stake?

Cost savingsCost savings of $100-230 billion associated with Internet of $100-230 billion associated with Internet related productivity gains. related productivity gains.

Productivity gainProductivity gain - .43% (approximately ½ of the projected - .43% (approximately ½ of the projected productivity gain)productivity gain)

Expected financial Impact through 2010 of Internet Expected financial Impact through 2010 of Internet Business solutions in U.S.: Business solutions in U.S.: – Revenue increases - $1.55 trillionRevenue increases - $1.55 trillion– Cost savings of $.528 trillionCost savings of $.528 trillion

Failure to improve broadband performance could reduce Failure to improve broadband performance could reduce productivity growth by 1%productivity growth by 1%

Sources: Litan and Rivlan (2001), Ferguson (2002),Varian, et al, (2002), Lehr (2005)

What to do next: An What to do next: An Assessment?Assessment?

Today’s debate makes your head spin: Today’s debate makes your head spin: – Intelligence on the inside or outside of the NetIntelligence on the inside or outside of the Net– Duopoly, conscious parallelism, contestable marketsDuopoly, conscious parallelism, contestable markets– TrinkoTrinko, , Brand XBrand X, Deep Packet Inspections, peering,…, Deep Packet Inspections, peering,…

Complication (obfuscation) is the friend of self-Complication (obfuscation) is the friend of self-serving argumentation.serving argumentation.

An enunciation of, and adherence to, basic An enunciation of, and adherence to, basic economic principles holds the promise of economic principles holds the promise of providing the basis of sound policy (and providing the basis of sound policy (and minimally promotes the “do no harm” principle)minimally promotes the “do no harm” principle)

Back to the Basics: Back to the Basics: Alfred Marshall Alfred Marshall

"Economics is the study of mankind in the ordinary business of life."

Alfred Marshall

“The Father of Supply and Demand”

““Insatiable” Consumer Demands: Insatiable” Consumer Demands: the Internet or otherwisethe Internet or otherwise

““He desires not merely larger quantities of the things he has been accustomed He desires not merely larger quantities of the things he has been accustomed to consume, but better qualities of those things; he desires a greater choice of to consume, but better qualities of those things; he desires a greater choice of things, and things that will satisfy new wants growing up in him.” things, and things that will satisfy new wants growing up in him.”

– Alfred Marshall, Alfred Marshall, Principles of EconomicsPrinciples of Economics, Book III, 1890., Book III, 1890.

In general -- “[C]onsumers always prefer more of any good to less…In general -- “[C]onsumers always prefer more of any good to less…consumers are never satisfied or satiated…” consumers are never satisfied or satiated…”

– R. Pindyck and D. Rubinfeld R. Pindyck and D. Rubinfeld MicroeconomicsMicroeconomics, 2005, 2005

Internet -- “Video content once reserved to limited distribution and schedule is Internet -- “Video content once reserved to limited distribution and schedule is now readily available - on demand - on Internet properties big and small. The now readily available - on demand - on Internet properties big and small. The rush of video content online has been met with near rush of video content online has been met with near insatiableinsatiable consumer consumer demand…”demand…”

BurstMedia, December 2006BurstMedia, December 2006

The Coming “Exaflood”The Coming “Exaflood”

“One of the key possibilities for 2007 is that the Internet could be approaching its capacity.” – Deloitte Telecommunications Predictions, TMT Trends

2007.

At the Amsterdam Internet exchange -“Daily traffic At the Amsterdam Internet exchange -“Daily traffic exceeded one petabyte in February 2006, and by exceeded one petabyte in February 2006, and by October 2007 the exchange is forecast to be handling October 2007 the exchange is forecast to be handling two petabyte per day… equivalent to one trillion two petabyte per day… equivalent to one trillion pages of standard printed text.”pages of standard printed text.”

Sources of Demand GrowthSources of Demand Growth

Downloading one hour sitcom consumes 1700 times the Internet bandwidth as pulling up an average website.

A one hour HD TV show would require 17,000 times the Internet bandwidth as pulling down a website.

Downloading a single high definition movie consumes more bandwidth than does the downloading of 35,000 web pages.

February 2007– Time Warner begins marketing cell phone-based television service– TiVo and Amazon announce plans to sell downloaded TV and

videos to TV sets via Broadband. (Reuters Feb 6th)

Infrastructure and Content:Infrastructure and Content:“Ketchup and Hot Dogs”“Ketchup and Hot Dogs”

Internet Infrastructure Contents and Applications

Broadband Infrastructure and Content are largely Demand-side complements

SupplySupply

Supply

Enticing more supply is costly

Q/t

$/Q

Broadband infrastructure is extraordinarily Broadband infrastructure is extraordinarily expensive and Economically sunkexpensive and Economically sunk

Cable Cable – $100b to move from one-way to two-way networks$100b to move from one-way to two-way networks

FiberFiber– To the home:Verizon $18b To the home:Verizon $18b – To the curb: AT&T $5bTo the curb: AT&T $5b

WiMax WiMax – Sprint Sprint

» $3b in 4g, “First to market next generation network advantage” $3b in 4g, “First to market next generation network advantage”

» 100 million people in 2008100 million people in 2008

Cost per home of next generation broadband Cost per home of next generation broadband (fiber) facilities = $1,400 per home. (fiber) facilities = $1,400 per home.

Demand Can outstrip Supply Demand Can outstrip Supply

Without an incentive to economize on usage, congestion Without an incentive to economize on usage, congestion can become quite serious. Indeed, the problem is more can become quite serious. Indeed, the problem is more serious for data networks than for many other congestible serious for data networks than for many other congestible resources because of the tremendously wide range of usage resources because of the tremendously wide range of usage rates. On a highway, for example, at a given moment a rates. On a highway, for example, at a given moment a single user is more or less limited to putting either one or single user is more or less limited to putting either one or zero cars on the road. In a data network, however, single zero cars on the road. In a data network, however, single user at a modern workstation can send a few bytes of e-user at a modern workstation can send a few bytes of e-mail or put a load of hundreds of Mbps on the network. mail or put a load of hundreds of Mbps on the network. – Jeffrey K. MacKie-Mason and Hal VarianJeffrey K. MacKie-Mason and Hal Varian– ““Economic FAQs About the Internet”Economic FAQs About the Internet”– Journal of Economic PerspectivesJournal of Economic Perspectives

The Role of Technology and/or EntryThe Role of Technology and/or Entry$/Q

Q/t

S1 S2

Q1 Q2

P

How to ensure that Demand is met?How to ensure that Demand is met?

The AlternativesThe Alternatives– National ownership & central planning National ownership & central planning

» ““The Internet is just too important to leave to the market”The Internet is just too important to leave to the market”

– Total Laissez faireTotal Laissez faire

– Promote supply, entry with fundamental reliance on market Promote supply, entry with fundamental reliance on market mechanism with antitrust and regulatory backstopmechanism with antitrust and regulatory backstop

How to ensure that demand is met?How to ensure that demand is met?The Role of the Price mechanismThe Role of the Price mechanism

Consumers prefer low (zero) pricesConsumers prefer low (zero) prices

Supply is simply unforthcoming in the Supply is simply unforthcoming in the absence of prices that exceed costsabsence of prices that exceed costs

Prices ration demand and send positive Prices ration demand and send positive signals to suppliers regarding the value that signals to suppliers regarding the value that consumers place on a good or service.consumers place on a good or service.

Two-sided MarketsTwo-sided Markets

Content and Applications Providers

Households &Businesses

Households &Businesses

Internet Infrastructure

Magazines, Newspapers

Stuff Providers

Alfred Marshall on solving shortagesAlfred Marshall on solving shortages

““When therefore the amount produced (in a When therefore the amount produced (in a unit of time) is such that the demand price unit of time) is such that the demand price is greater than the supply price, then sellers is greater than the supply price, then sellers receive more than is sufficient to make it receive more than is sufficient to make it worth their while to bring goods to market worth their while to bring goods to market to that amount; and there is at work an to that amount; and there is at work an active force tending to increase the amount active force tending to increase the amount brought forward for sale.” brought forward for sale.” – Principles of EconomicsPrinciples of Economics, 1890, Book V, , 1890, Book V,

Chapter 3Chapter 3

The Adequacy of the Current The Adequacy of the Current Internet Pricing ModelsInternet Pricing Models

[T]here is a real problem for the continued exponential growth of the traffic and the markets' current attraction to … flat rate pricing…provisioning continual investment to address the real growth in traffic is not an obvious outcome that's going to indeed happen, and that if that were to be forestalled I believe that would have deleterious effects for the whole Internet value chain.

William Lehr, MITFebruary 13, 2007

Policy OptionsPolicy Options Current Frame Imposes regulation on treatment of bits based Current Frame Imposes regulation on treatment of bits based

on concern over competition and fear of discrimination or, on concern over competition and fear of discrimination or, alternatively, leave policy as is.alternatively, leave policy as is.

These options are predicated on a certainty that doesn’t exist.These options are predicated on a certainty that doesn’t exist.– Potential for upgrading policyPotential for upgrading policy

» Policy fast lane (enhanced and expedited Policy fast lane (enhanced and expedited complaint/enforcement process regarding competition)complaint/enforcement process regarding competition)

» Reduce barriers to entry into intermodal competitionReduce barriers to entry into intermodal competition Municipal Franchise reformMunicipal Franchise reform

» Remove capacity constraints (Barriers to entry) in Remove capacity constraints (Barriers to entry) in alternative wireless technologiesalternative wireless technologies

» More, detailed international benchmarkingMore, detailed international benchmarking» Promote, as possible, new technologies (BPL)Promote, as possible, new technologies (BPL)

“Whereas we have grafted the Internet onto our lives, [our children] are growing up in it and have never known otherwise and they will shape it ultimately into something that we can't fathom. Our job in the meantime is to not screw it up.”

Deborah Platt MajorasChairman, Federal Trade Commission Feb. 13, 2006

Conclusion