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The Case Against a Neutral Net

The following is excerpted testimony offered by J. Gregory Sidak, visiting professor of law at Georgetown University Law Center, before the Senate Commerce, Science and Transportation Committee on Feb. 7:

“Net neutrality” obligations would require a telecommunications carrier to operate its broadband network so that no packet of information is treated as inferior to others in terms of its urgency of delivery. Under “net neutrality” I can take comfort in knowing that my son’s Internet chatting about what agent Jack Bauer did on last night’s episode of 24 will receive the same priority of delivery as my file transfer of this testimony to the Committee’s staff.

Companies like Google, eBay, and Yahoo might believe that such an outcome works to their private economic advantage, but that short-run view would neglect the disincentive that “net neutrality” obligations would create for private investment in the very broadband infrastructure upon which these companies rely to deliver their content and applications to consumers.

To understand the harm that “net neutrality” obligations pose to economic welfare, Congress needs to appreciate six salient economic features of telecommunications networks.

The first economic consideration is that a broadband network requires substantial sunk investment. Private investors will fund the construction of a broadband network only if there is a reasonable expectation that the company making that investment will recover the cost of its investment, including a competitive return on capital. Sunk investment is not a one-shot deal; sunk investment is made continuously over time. Therefore, as soon as it is understood that a new regulatory obligation or regime like “net neutrality” will jeopardize a firm’s recovery of its sunk costs, the capital markets will demand a higher risk-adjusted return.

The second economic consideration is that a broadband network exhibits economies of scale. The large sunk costs of building a broadband network imply that the marginal cost of providing service to one more consumer is very low. However, marginal cost pricing is insufficient to recover even the average variable cost of the network, much less the average total cost, which would be necessary to recover the sunk costs of building the network.

The third economic consideration is that a broadband network exhibits economies of scope. In other words, there are synergistic “common costs” to producing multiple products over the same network. The fourth economic consideration is that differential pricing … can increase economic welfare because it enables a firm to lower the price to consumers who would otherwise be priced out of the market if the firm were constrained to charge a higher uniform price.

The fifth economic consideration is that telecommunications services have joint demand. For example, a telephone call is valued by both the caller and the recipient, and a visit to a Web site is valued by both the consumer doing the browsing … There is no basis in economic theory to presume that it would be socially optimal for end users to pay for all of the cost of building a high-speed broadband network while the companies that deliver content or applications to those same end users over that network and therefore derive substantial economic advantage from its use pay nothing.

The sixth economic consideration is that telecommunications networks are susceptible to congestion. For that reason, correct price signals must be used at every possible point in the network so that users who congest the network bear the social cost of their behavior.