Mike Wendy and I have just released a new PFF white paper, "The Constructive Alternative to Net Neutrality Regulation and Title II Reclassification Wars." In it, we discuss the Federal Communications Commission's (FCC) misguided effort to pigeonhole the Internet and broadband networks into the regulatory regime of a bygone era. Specifically, the agency's recent efforts to impose "Net neutrality" regulations on broadband networks, or reclassify them as Title II services under the Communications Act, raises the likelihood of delayed or foregone investment, will discourage innovation at both the core and edge of networks, and increases the likely politicization and bureaucratization of high-technology policy more generally.
We believe there are constructive alternatives to such a destructive regulatory path. The better alternative would be based on (1) a new legislative framework centered on an FTC-like enforcement model of ex post adjudication grounded in antitrust law; (2) increased industry self-regulation, technical collaboration, and alternative dispute resolution mechanisms; and (3) greater reliance on community policing and expert third-party oversight.
For more details, you can read our entire paper down below the fold:
The Constructive Alternative to Net Neutrality Regulation and Title II Reclassification Wars
The Federal Communications Commission (FCC) has embarked on what can only be described as a "by any means necessary" effort to pigeonhole the Internet and broadband networks into the regulatory regime of a bygone era. The ramifications of this crusade for the digital economy will be profound, as it raises the likelihood of delayed or foregone investment, discouraged innovation at both the core and edge of networks, and the increasing politicization and bureaucratization of high-technology policy.
Luckily, there are constructive alternatives to such a destructive regulatory path. As explained below, the better alternative would be based on: (1) a new legislative framework centered on a Federal Trade Commission-like (FTC) enforcement model of ex post adjudication grounded in antitrust law; (2) increased industry self-regulation, technical collaboration, and alternative dispute resolution mechanisms; and (3) greater reliance on community policing and expert third-party oversight.
The "Third Way" Is the Old Way in Drag
For the past year, FCC Chairman Julius Genachowski has been laying the groundwork for imposing "Net Neutrality" regulations on broadband networks and has stepped up this crusade in recent weeks. He has done this despite the D.C. Circuit's recent decision in Comcast v. FCC, which held that the agency lacked the authority to sanction Comcast for supposedly violating Net Neutrality principles that did not have the force of law. The Court concluded that the FCC's "ancillary jurisdiction" under Title I of the Communications Act was insufficient to allow the FCC to regulate Comcast's actions.
Chairman Genachowski has now concocted an alternative regulatory blueprint that he describes as a "Third Way." He claims that, simply by reclassifying the transmission component of broadband services under Title II of the Communications Act and adopting "a restrained approach" to regulating it, America can have the best of both worlds: innovation and investment, as well as (government-ensured) "openness."
In reality, however, Genachowski's "Third Way" is really nothing more than the old way the agency did business for decades--and with disastrous results. The history of communications under strict Title II regulation was not a pretty one: Stagnant markets, limited consumer choices, and lackluster innovation were the hallmarks of the old regulatory era. In attempting to protect consumers, federal and state regulations perversely harmed them by preserving barriers to entry that thwarted robust (or even minimal) competition and innovation.
The Telecommunications Act of 1996 marked an important turning point in this miserable history, as Congress finally acknowledged that facilities-based competition was possible and preferable to the regulated monopoly era of the past. The purpose of the measure, as the first six words of the Act made clear, was "To promote competition and reduce regulation." Unfortunately, however, lawmakers were reluctant to completely cut ties with the past regulatory regime, and open access rules were included in the Telecom Act that forced incumbent telecommunications companies--but, importantly, not cable operators--to unbundle and share with their rivals certain elements of their networks.
Thankfully, between 2002 and 2004, the FCC gradually came back to the pro-deregulatory intent of the Act and wisely began dismantling this "forced access" regime for incumbent-provided broadband services. In doing so, it finally signaled to markets that the true era of all-out facilities-based investment and competition was to begin. For wireline and cable companies in particular, the gloves came off, unleashing a torrent of investment and growth that continues to this day. Thus, it is frequently forgotten that America's experiment with facilities-based competition in the broadband world is really less than a decade old. Before then, regulatory paralysis generally ruled the day; but since 2005, broadband providers have been able to invest with greater confidence that they could recoup the cost of their significant investments. This, in turn, has spurned heretofore unseen levels of digital innovation--at both the core and edge of digital networks.
Why "Just Trust Us" Isn't Good Enough
That's what makes the FCC's new approach so troubling. It represents a preemptive surrender on America's experiment with facilities-based competition and the beginning what Scott Cleland has correctly labeled a "de-competition policy." To return to Title II regulation would be to transport the broadband business back to the era of rotary dial telephony, when government had more control over communications networks but, as noted, competition was non-existent and consumers and subsequent product and service innovation suffered.
Chairman Genachowski promises to exercise "restraint" and use a "light touch" by only applying certain provisions of Title II. Such promises are meaningless in the highly politicized world of communications policy. Regulators exist to regulate. That is their job, and where their institutional incentives direct them. As Craig Moffett of Bernstein Research predicts, the FCC's move,
very specifically opens the door to price regulation, and it makes other regulation materially more likely in the future. The FCC has voted itself a loaded gun, pointed it at the Carriers (cable and telco alike) and then promised not to shoot. The world doesn't seem like a safer place.
Of the six powers the Commission claims it will use only sparsely, Sections 201 and 202 seem most ominous. Section 201 places a duty on carriers to extend services upon "reasonable request." It also allows the Commission to compel interconnection with other facilities where deemed by the Agency to be in the "public interest." Finally, Section 201 props open the door to full-on rate regulation, instructing carriers that only "just and reasonable" charges, practices, and classifications will be considered lawful. Section 202 goes further by, among other means, proscribing common carriers from "unreasonable discrimination in charges, practices, classifications, regulations, facilities, or services..."
Similar language can be found in the six Net Neutrality principles proposed by the FCC as part of its Open Internet / Net Neutrality Proceeding. The Court of Appeals in Comcast v. FCC said the Commission lacked the requisite authority to enact such regulations in that context, so it remains a delicate tightrope walk--if it can be accomplished at all--to do so with a Title II "sleight of hand." Moreover, it's important to recall that this regulatory regime was never applied to the cable sector as it now apparently will be. This raises additional grounds for a legal challenge, since the FCC would be unilaterally, without specific congressional authority, upending the regulatory standard (and its underlying investment assumptions) that the cable industry has operated under ever since it got into the broadband business.
Along these lines, reclassification efforts would likely end up with the imposition of common carrier status on other entities that are not operating as common carriers today. Consequently, the question of "Who gets the regulatory tar and feathers?" will now be asked about a broader array of actors, well beyond the "usual suspects." What about wireless providers of broadband? Or Broadband over Powerline (BPL) offerings (where they still exist)? And do online service providers--search and application providers such as Google, Yahoo, Microsoft, Apple, etc.-- get brought into the ambit of regulation, too? For isn't anything connected to the network actually the network itself? And, if this is so, would it be so implausible, given the nature of regulatory creep, to see these neutrality / reclassification rules expanded to cover "port neutrality," "search neutrality," "device neutrality," or "software code neutrality," among other proscriptions to keep the Internet "open" and "free"? And then there are the services yet to be developed.
Uncertainty: An Investment and Innovation-Killing Machine
It is unclear whether the D.C. Circuit (or any other court) will accept the FCC's expansionist reading of its existing statutory reclassification authority if and when all this is tested in court. Regardless, in the interim, "all of this could lead to a long period of regulatory uncertainty, which is one of the things that businesses of all stripes fear the most," notes Brad Reed of Network World. That uncertainty will translate into delayed or forgone investment and innovation as the ensuing litigation nightmare takes years to wind its way through the courts. "Markets abhor uncertainty," Moffett notes, and yet, with the FCC's recent Title II announcement, "we got uncertainty in spades." Like other market analysts, Moffett fears "an extended period of profound regulatory uncertainty--some might say chaos--potentially for years, until the matter is finally adjudicated by the Supreme Court." He doesn't mince words about the impact of all this on markets:
We would expect a profoundly negative impact on capital investment. To the extent that reduced network investment increases network congestion (particularly if these regulations apply to wireless networks), then the implications for downstream equipment and applications providers are also negative, inasmuch as the user experience can be anticipated to degrade. This development is an unequivocal negative development for almost all of our coverage universe, most significantly for the cable operators and Verizon (which is nearing completion of a $23 billion investment in a new FiOS network that might conceivably now be subject to Open Access for competitors).
Put more simply, instead of working to promote market confidence and facilities-based broadband investments, fewer players will be incentivized to take the enormous risk of investing in new infrastructure. Capital markets and investors are rightly tightfisted when the threat--even the whiff--of government-created scarcity through regulation rears its ugly head. The long-term impact could be even worse. Over twenty respected communications economists and experts recently submitted a statement to the FCC arguing that, "To the extent regulatory uncertainty prevents parties from engaging in efficiency-enhancing conduct ... firms are less likely to engage in the investment or innovation that such conduct and contracts would otherwise have enabled." And a new study by economist Coleman Bazelon of The Brattle Group reveals that, "New network neutrality regulations proposed by the FCC could slow the growth of the broadband sector, potentially affecting as many as 1.5 million jobs, both union and non-union, by the end of the decade." Moreover, "The possibility that such losses would be offset by gains in other parts of the Internet economy is remote," he concludes.
The damage will not be contained to primary markets; the regulatory spill-over effect also means less innovation at the edges due to fewer, and less sophisticated, platforms upon which to build new edge-based services. As Daniel Brenner of Georgetown University Law Center correctly argues:
[T]here is significant loss to innovation if the layer approach disallows those who provide the physical layer from providing services higher up the chain. Opportunity for innovation is lost if the physical layer can adopt only one form of operation as a nondiscriminatory common carrier. And a dumb-pipe mantra runs counter to the innovation-rich policy concerns of layer advocates, even while it is believed to protect innovation of the Internet's edge.
Sadly, on the whole, the only ones who seem to win are the regulators themselves, a strange outcome indeed, when their ostensible duty is to promote broadband ubiquity and up-take "so far as possible, to all the people of the United States..."
In essence, therefore, the FCC's "Third Way" proposal represents a call for the forced commoditization of broadband networks and would necessitate a return to the rate-of-return regulatory methods of the past. It would freeze network innovation in place and stop the clock on facilities-based competition--one of the great American economic success stories of the past quarter-century. Reclassification of broadband will mean a quick death for the Telecom Act's goal, "to promote competition and reduce regulation." For these reasons, this "de-competition" approach should be rejected in favor of an alternative approach that does not discourage investment, innovation, or competition.
A New Legislative Framework: DACA
There is an alternative to the "nuclear option" pursued by the FCC. In light of immense technological advances and the convergence communications markets, many experts have begun coalescing around the idea that the present "service-based" regulatory model--exemplified by the Communications Act of 1934--cannot adapt to present day, let alone evolving marketplace demands. Far from eschewing regulation entirely, though, there's still a role for regulators, albeit in a more limited manner, patterned to a large extent on notions of competition theory and consumer harm instead of "title-based," preemptive regulatory meddling.
In 2005-06, The Progress & Freedom Foundation brought together over 50 scholars--a non-partisan collection of lawyers, economists, engineers and other experts--with the ultimate aim of crafting a new regulatory framework more appropriate for a frequently-changing communications landscape. The resulting Digital Age Communications Act (DACA) project proposed scraping the old regulatory "silos" (Title II for telecom, Title III for broadcast, Title VI for cable) and replacing them all with a Federal Trade Commission-like "unfair competition" standard. Under DACA, the FCC would retain some baseline regulatory authority to oversee the marketplace, but this authority would be limited and based upon more settled principles of competition law and economics--essentially, streamlined antitrust regulation. Serious anticompetitive actions that lead to demonstrable consumer harm would still be policed and punished under this model. But this would be done on a limited, case-by-case basis without prejudging business models or practices or by imposing prophylactic regulatory regimes.
In essence, DACA stood for the proposition that an ex post approach to regulatory oversight was preferable to ex ante forms of preemptive and prophylactic regulation by the FCC. Indeed, the DACA model was based on a model we already have in place: antitrust laws and the adjudicatory process administered by the Federal Trade Commission. The DACA experts, therefore, advocated not that the FCC be abolished, but that an FTC-like enforcement model be imported into the FCC.
To be clear, this is regulation. In fact, when the DACA working group released its initial framework in June 2005, some critiqued the plan on the grounds that it did not do enough to tie the hands of regulators. Others argued that there was no need to import a competition policy regime into the FCC when the FTC and Department of Justice remain perfectly capable of enforcing antitrust laws where anti-competitive conduct can be proven. While those concerns are understandable, they're also not very practical. Scrapping the FCC is untenable, especially since the FCC still engages in some sector-specific forms of regulation (spectrum standards, interconnection mandates, universal service administration, etc.) that Congress would likely insist remain within the hands of a sector-specific regulator. Nonetheless, the DACA framework would be vastly superior to the sort of heavy-handed regulatory approach currently on the books, or the even stricter "Mother, may I?" approach that some Net Neutrality proponents favor. DACA has the added advantage of not being as susceptible to the problems of regulatory creep and regulatory capture.
Because DACA allows regulators to operate with a truly light touch, it would be the best model for the FCC to adopt going forward to ensure that consumer welfare was served and beneficial innovation was not thwarted by a cumbersome, preemptive regulatory regime at the FCC.
Self-Regulation, Best Practices & "Norms" for Network Management
Buttressing the DACA model, while also keeping direct regulation to a minimum, is industry self-regulation. Some will protest, "that's like putting the fox in charge of the henhouse," for the Internet eco-system. But, the combination of self-regulation and industry norms / collaboration already works quite effectively. Notes FCC Commissioner Robert McDowell in his Open Internet proceeding statement, "the Internet is perhaps the greatest deregulatory success story of all time. It became successful not by government fiat, but by all interested parties working together toward a common goal."
An excellent example of diverse Internet companies with divergent interests working together can be seen in Verizon and Google's recent joint statement to the FCC, which outlines their common-ground approach for an open Internet. While the two companies may sit at opposite ends on the Net Neutrality debate, the two businesses acknowledge that they "rely on each other," and consequently feel a shared responsibility to discuss how they can ensure that consumers get the services, products and information they want; network investment and growth can be continually boosted; and how they can work together to keep the Internet "open."
Both companies agree that the Internet has thrived primarily via an absence of regulation. Much of this growth has occurred through the cooperative efforts of many in the Internet eco-system. To this end, they have articulated seven "core values" to guide the conduct of all Internet "players," including: (1) Preserving Openness; (2) Encouraging investment and innovation in broadband networks; (3) Providing users with control; (4) Providing users with information; (5) Maintaining a balanced intellectual property policy; (6) Keeping Internet applications, content, and services free from communications regulation; and (7) Providing a leadership role for expert technical bodies. In their view, by hemming to these long-held values--which have kept government regulation largely out of the picture--the Internet eco-system can continue to innovate and grow as it has, virtually unabated, since its inception.
Community Policing, Independent Review & Dispute Resolution Processes/Fora
Disputes and other bumps in the road will inevitably arise. Growth, driven by fierce competition, has a way of doing that. But government intervention and policing need not be automatic. From the birth of the Internet, non-state-controlled governance bodies have guided the medium's expansion, all with the goal of keeping the Internet open and evolving with a minimum of government meddling. As network engineer Richard Bennett explains:
The InterÂnet is an adaptable system because its experimental character provides it with a built-in learning function that enables engineers to make network and protoÂcol design decisions empirically. It's fair to say that its design is dictated more by a commitment to continÂual improvement than by obedience to hard and fast rules: It was meant to be a system in which experiÂments would have the consequence of improving the network.
Today, a great variety of entities continue to labor to self-regulate core aspects of the Internet. These largely self-funded, volunteer-staffed, non-profit groups collaborate daily, behind the scenes, to promote abundance and competition over scarcity and regulation through "flat" Internet governance mechanisms that work from the "bottom up" instead of through "top-down" government mandates. Examples include the Internet Society (ISOC), the Internet Engineering Task Force (IETF), the Internet Engineering Steering Group (IESG), the Internet Research Task Force (IRTF), the Internet Research Steering Group (IRSG), the Internet Architecture Board (IAB), the P4P Working Group, and, to some extent, the Internet Corporation for Assigned Names and Numbers (ICANN).
The joint Verizon/Google statement builds upon the strength of this well-worn model. As they suggest, self-governance should be the touchstone. To contain the occasional demand for government prophylaxis, among other things, they suggest the creation technical advisory groups to provide for quick, non-government-driven dispute resolution fora, best practices and industry-led guidance. Similar to these efforts, groups like the Net Neutrality Squad, Computer Professionals for Social Responsibility, and the Berkman Center for Internet & Society's Herdict project focus on Internet end-users "to help keep the Internet's operations fair and unhindered from unreasonable restrictions." They look to identify and address anticompetitive and discriminatory behavior on the Internet, and provide a forum for "fostering cooperation and mutually agreeable methodologies whenever possible--aimed at keeping the Internet a maximally unhindered, useful, competitive, fair, and open environment for the broadest possible range of applications and services." Meanwhile, the Internet community itself will provide millions of "watchdogs" who constantly monitor and report on carrier behavior. "The Internet culture is full of feedback and referral mechanisms," notes Brenner.
The important take-away from this is: Efficient and effective self-governance models and tools exist now to guide the expansion of the Internet. This is not to say government involvement is never warranted, but clearly, the default setting is, and has always been, a minimum of direct government regulation. Perhaps Commissioner McDowell put it more aptly:
Since [the Internet] was opened up for public use, as a free society we have worked hard to ensure that the Internet remains robust, safe and open. Also, since its inception, uncounted dedicated souls have worked to ensure that the Internet works, period. Since the early days of state-run ARPANET, network management and Internet governance initiatives have migrated further way from government regulation, not closer to it. This evolution away from government intervention has been the most important ingredient in the Internet's success.
That is the sensible path to continue along. Preemptive, prophylactic regulation of the Internet and broadband networks, by contrast, will smother experimentation and entrepreneurialism while stifling continuous technological improvements and investments.
 Craig Moffett, Bernstein Research, Quick Take - U.S. Telecommunications, U.S. Cable & Satellite Broadcasting: The FCC Goes Nuclear,May 5, 2010, at 1.
Id. at 2. Similarly, Anna-Maria Kovacs argues, "What is inevitable is a lengthy period of uncertainty, first about the precise shape of the order, then about its fate in court, and then about the ways it will be implemented, and then about the fate of the implementation orders in court..." Anna-Maria Kovacs, Regulatory Source Associates, Telecom Regulatory Note, May 6, 2010.
 Early stock market reaction to the FCC's new "Third Way" plan hasn't been encouraging. "Since announcing that the FCC will reclassify broadband as a Title II... service a week or so ago, Genachowski has placed a cloud over cable stocks. Cablevision, Comcast, and Time Warner Cable are down anywhere from 6%-11% as the government's heavy hand of regulation moves closer to reality." Bob Faulkner, The Cloud Hanging Over Cable Stocks,Minyanville,May 17, 2010, www.minyanville.com/businessmarkets/articles/cable-stocks-networks-fcc-fcc-chairman/5/17/2010/id/28324?page=1.
 Statement of Robert McDowell, Open Internet NPRM at 96.
 As Bennett notes, "Steady improvement, punctuated by brief periods of radical disruption, is the normal state of afÂfairs in evolving technical systems and should not be feared. It is likely that the only principle of the Internet that should survive indefinitely is the principle of conÂstant change." Bennett, supra note 33.