Hi everyone, today's article of the week covers the theory and debate around Net nutrality.

The article can be found here.

Our summary this week is by /u/randy_newman1502:

Net neutrality has once again emerged as an issue in the United States. This week's article of the week is from the Journal of Economic Perspectives (JEP). The JEP is a journal that occupies a space between academic economics and the general interest press. The purpose of the JEP is to synthesise economic research and make it more accessible.

The purpose of this writeup is to summarize the article without editorialising, but everyone is encouraged to read it if they want a better understanding of the issues surrounding net neutrality.

First, we must define net neutrality. Broadly speaking, network neutrality is the idea that an internet service provider should treat all traffic the same regardless of where that traffic originates. For example, network neutrality would mean a firm like Comcast would not be allowed to ask Netflix to pay for privileged access to its network.

Like all things in economics, there are trade-offs involved, and the authors note the following:

The economic literature examining net neutrality is young, and it would be rash to conclude that researchers have spotted all the key economic trade-offs. So throughout we identify some of the important open questions in this topic. Moreover, as we survey the literature, we highlight one particular theme: There is little support for the bold and simplistic claims of the most vociferous supporters and detractors of net neutrality. The economic consequences of such policies depend crucially on the precise policy choice and how it is implemented. The consequences further depend on how long-run economic trade-offs play out; for some of them, there is relevant experience in other industries to draw upon, but for others there is no experience and no consensus forecast.

Let us begin by summarising the key arguments on both sides. One the one hand, many data carriers say that differentiating charges will allow them to manage congestion efficiently and to provide an incentive to invest and innovate. Content providers have conversely argued that the absence of network neutrality will deter them from reaching customers and discourage innovation.

The article begins with a simple model which posits a situation with two firms- an ISP and a content provider. The model also posits that broadband access and content are perfect complements to each other and thus, the demand for both depends on the total price an end user will have to pay.

The simple model produces a surprising result: when Comcast charges Netflix, nothing happens. The simple model Under this setting, the firms end up having a symmetric position where the profits are split in half and any alteration in the fee change neither changes the bill to the end user or the profits of the firms.

This is obviously a simple model and does not incorporate several important issues that are central to the tradeoffs surrounding net neutrality. Next, the authors posit a more realistic model [Insert Fig 1.]

In two-sided pricing, the ISP can charge a subscription fee p to users and a termination fee t to content providers for delivering their content. By contrast, in one-sided pricing, the ISP can only charge a subscription fee to users. A regulatory restriction can rule out two-sided pricing.

In this framing, net neutrality can be thought of as a requirement that the ISP provide the same service to all content providers and users, while charging a fee only to users.

The outcome that maximises social welfare in this scenario is when all content providers can contact all end users. Under certain assumptions, it can be shown that all two-sided pricing does is redistribute rents between content providers and ISPs, leaving end users unaffected.

However, when heterogeneity among consumers (in how much they value content) and content providers is introduced, it can be shown that:

one-sided pricing is welfare-superior if heterogeneity
among content providers is particularly pronounced, whereas two-sided pricing is welfare-superior if heterogeneity among end users is particularly pronounced.

When content producers can charge consumers directly (like Amazon with Prime, Hulu, HBO, etc) the economic insights are ambiguous and one should be wary of anyone making bold policy claims in favour of one or two sided pricing.

Other issues:

Congestion: Some types of data lose their value with delays (such as VOIP calls) while other types do not (downloading large files) since it is not as time-sensitive. It is surprising that more ISP's have not tried some kind of time-of-day pricing or peak pricing (similar to Uber's surge pricing). This could be welfare enhancing if capacity is provided with priority to high level traffic. This is an example of how doing away with net neutrality could be beneficial.

However, even this can be more complex than it seems. Choi & Kim (2010) illustrate how prioritised access could serve as a rent-extraction device.

Investment: A lot of attention has been paid to how abolishing neutrality will effect the incentives of ISP's to invest. There is concern that in the absence of neutrality, non-priority traffic will be pushed onto a "dirt road" versus the priority traffic that gets put on the "fast lane." An ISP could face incentives to "shade the quality of lower-quality products" in order to push users to upgrade to higher margin, higher quality products. However, according to the authors, "most practical net neutrality proposals permit tiered services to users" which ameliorates this issue.

Bourreau, Kourandi, and Valletti (2015) argue that under discrimination, investments in broadband capacity and content innovation are higher than under net neutrality, however, the risk of fast lane/dirt road dynamics is present even with competing ISPs.

The Choi & Kim article linked above also argues that a discriminatory regime can weaken content providers' incentives to invest out of a fear that an ISP could expropriate some of the investment's benefits which is something else to consider when evaluating the effects of neutrality on investment incentives.

Conclusion:

The question of whether net neutrality is "good" or "bad" is an open question. It is tough to get an answer if the question is framed in those terms in the first place because personal preferences are in play. The questions of "is net neutrality good for investment" or "does net neutrality encourage innovation" are more specific questions but tough to answer empirically. The best that can be said that there are certain circumstances where net neutrality is welfare decreasing and certain other circumstances where the opposite may be true.

This "Article of the week" attempts to review the literature and present simple models through which people can start to think about net neutrality in an economic framework. In other words, the situation is as the authors laid out near the beginning of the paper:

The economic literature examining net neutrality is young, and it would be rash to conclude that researchers have spotted all the key economic trade-offs. So throughout we identify some of the important open questions in this topic. Moreover, as we survey the literature, we highlight one particular theme: There is little support for the bold and simplistic claims of the most vociferous supporters and detractors of net neutrality.