Tag Archives: prices

Net Neutrality Politics: Moving Us Away from a Free, Open Internet

With the help of corporate sponsors like Netflix and Google, net neutrality has gone from being an unknown issue to garnering national attention. Like most fads, though, net neutrality’s popularity has grown far more rapidly than the public’s understanding of it, and people do not realize how unnecessary and destructive net neutrality policies actually are.

“Net neutrality” refers to a principle under which all types of information on the internet are delivered at equal speeds. In a neutral internet, an email from your grandmother will download to your computer at the same rate as a Netflix video. In a non-neutral internet, by contrast, some information could get prioritized, necessarily slowing the rest. Content producers (such as Netflix) and end-users tend to be in favor of net neutrality because they benefit from a vast diversity of content on the internet, and no one wants to run the risk of having their preferred content throttled (slowed).

Opponents of net neutrality tend to include internet service providers (ISPs), such as phone and cable companies, who believe that tailoring their networks to fast-track certain types of content could lead to better end-user experiences and cost savings.

The net-neutrality principle has been invoked in several pieces legislation and proposed administrative rules over the past eight years. Each of these acts would, to varying degrees, restrict the autonomy of ISPs. As a result, the term “net neutrality” now denotes a specific set of public policies, and not just a principle.

Like the proponents of many government regulations, net neutrality supporters will often invoke the public interest, the protection of some disadvantaged group, and/or the promotion of economic efficiency. Touchy-feely catchphrases like “keep the internet free and open” and “all bits are created equal” abound, along with the assertion that net neutrality will bolster marketplace competition by relieving the burden of bandwidth costs for startup tech companies. Proponents also assert that net neutrality will prevent ISPs from arbitrarily censoring (competitors’) content on their networks.

The proponents of such regulation seem to concede the benefit of market competition—a refreshing sign—but they fail to see the contradiction created by invoking it. Net neutrality is properly seen as a hindrance to competition, not a facilitator.

In order to compete in a market, companies must differentiate themselves in a way that satisfies the consumer. This is innovation. One method ISPs have to satisfy the wants and desires of their customers is to expedite the information their customers consume. The net neutrality regulations proposed by the Federal Communications Commission (FCC)—recently struck down in January—would have prevented this, stifling innovation in the provision of internet services. As Larry Downes noted in November:

In all, the FCC’s Open Internet order itself cataloged a dozen major non-neutral technologies, protocols, and business arrangements that have long been necessary parts of the Internet. Sensibly and of necessity, the agency granted exceptions from the rules for each and every one of them, recognizing that the “open” Internet, at least from an engineering standpoint, was anything but. For the Internet to continue functioning at all, the rhetoric had to give way to reality.

But there was no way for the rules to preemptively grant similar permission to any future network optimization technologies, other than to caveat all of the rules with exemptions for “reasonable network management.” That term couldn’t be defined, however, meaning that any future innovations will require FCC approval before large-scale implementation.[i]

In other words, such an obstacle to innovation and experimentation in network management could spell higher costs and a far lesser quality of service for end-users and content providers alike. This seems like a terrible tradeoff, since even an absence of government net neutrality regulations would not prevent ISPs from adopting net-neutral practices; if consumers demanded such practices, they could simply switch from a non-neutral ISP to a neutral one. The same is true for content providers—not only the giant companies like Facebook, Netflix, and Amazon; smaller companies and (yet-to-exist) startups may also switch among ISPs if they believe that their content is being discriminated against. This would be a system of true market competition.

In response, net neutrality advocates quickly (and rightly) point out the monopolistic state of the broadband internet market. The FCC has reported that of the 132 million households in the United States, only 47 million (roughly 35%) have access to four or more video programming distributors (i.e., cable, satellite, and telephone companies); cable companies alone have a market share of 56% among these distributors, and of the roughly 1,100 cable companies in the United States, the top five of them (in market share) account for nearly 82% of all video programming subscribers.[ii] Given that all of these companies also provide broadband internet services to many of their customers, the ISP market looks incredibly uncompetitive.

The uncompetitive nature of the industry would seem to refute the argument that net neutrality stifles innovation—there’s no need for companies to innovate anyway if the market is cornered. Since Comcast and similar companies so effectively control their respective markets, there is virtually no recourse for a dissatisfied customer, which removes the normal incentives for companies to improve services and cut costs.

For most people, unfortunately, this is where the debate ends. Although many will concede the benefits of competition among ISPs, they dismiss those benefits as immaterial, since an effective monopoly exists in the largest markets. Now the only available option they see for ensuring fair or neutral business practices is for government to impose net neutrality upon the industry.

But this disregards the important question of how the industry became so uncompetitive in the first place. If the ISP market is naturally and inevitably monopolistic, it might lend support to net neutrality advocates. But if it is not, then net neutrality may unnecessarily stifle innovation and raise costs. Before we propose policies, we need to ask, “Why is there effectively a monopoly in internet service markets?”

Basic economic theory informs us that monopolies can only endure as long as no new companies enter the market to provide the same (or better) service at a lower price. So why haven’t more companies entered the market to upend the entrenched giants?

There are a number of up-front costs associated with starting a cable company and/or entering a cable market. Building the initial cable infrastructure is one of these costs, but another significant, yet often unmentioned cost is that of acquiring cable franchises. In most states, cable companies must obtain a cable franchise from each and every municipality in which they want to do business. Large companies can easily expand into new markets because they have lots of cash with which to pay licensing fees; but for smaller/startup companies, the licensing requirements present an insurmountable barrier to market entry. Encouragingly, 21 states have passed cable franchise reform bills, meaning that cable companies need only obtain one license to operate within the entire state. In the 29 remaining states, however, cable companies must still work through the old, inefficient system.

Evidence indicates that the entry of companies into previously uncompetitive ISP markets does reduce cable prices and provoke efforts from the incumbent cable companies to improve services. In response to entry by AT&T, which offers video services over telephone lines (and is thus not subject to cable franchise requirements), Comcast of Santa Rosa, CA, rushed to deliver “new features [video-on-demand, more channels] in Santa Rosa […]” In Houston, similarly, Comcast pledged to offer more “linear and high-definition channels, video-on-demand titles and digital phone features” following potential AT&T entry.[iii] A Bank of America study also observed basic cable price reductions of between 28% and 42% in areas of Virginia, Texas, and Florida where Verizon rolled out its FiOS video service.[iv]

The lesson from these stories is clear: Wherever ISPs are able to circumvent onerous cable franchise requirements and enter the market, services and pricing improve. The solution to the lack of market competition, therefore, is not to implement new government regulations, but to repeal the regulations we already have. Getting rid of cable franchising would abrogate the need for net neutrality while also improving consumer choice and quality of services. These reforms, not innovation-stifling net neutrality, will be a crucial step toward a truly free and open internet.

[i] Downes, L. (2002). What Verizon’s Net Neutrality Challenge Is Really About. Forbes. Retrieved from: http://www.forbes.com/sites/larrydownes/2013/09/11/what-verizons-net-neutrality-challenge-is-really-about/

[ii] Federal Communications Comission. (2013). Fifteenth Report. Retrieved from: https://apps.fcc.gov/edocs_public/attachmatch/FCC-13-99A1.pdf

[iii] Singer, H.J. (2007). The Consumer Benefits of Telco Entry in Video Markets. Retrieved from: http://www.justice.gov/atr/public/workshops/telecom2007/submissions/228100.htm

[iv] Bank of America Equity Research. (2006). Battle for the Bundle: Consumer Wireline Services Pricing.

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Another Reason to Like Rich People

They don’t just create jobs…

One of the most common complaints of a free market system comes from consumers who, while desiring a nascent product, are too in-affluent to buy it. I frequently see this sentiment emerge while reading the various technology and automotive blogs across the internet, where new products are introduced several times each day. Experienced bloggers and commentators are adept at shrugging off their disappointment in these situations; they know that consumers need only wait, and the product will eventually become affordable. Many people, however, don’t seem to understand how this occurs, and their bewilderment too often turns to impatience. To alleviate this problem, let me attempt an explanation of how a good or service becomes affordable.

First, an entrepreneur/producer has an idea for a product, either to create a new one or to improve upon an existing one. Because the product is relatively new and strange, the cost of building it is high. It requires lots of investment, research, time, and labor to create. The high cost of production necessarily translates into a high sale price.

Because the initial sale price of the new product is so high, relatively few people will be able to buy it outright—this small group of people consists of the most affluent among us. However, if the rich buy enough of the product, potential producers will interpret this as evidence of growing demand, and they will enter the market to capitalize on it. The subsequent combination of increased product supply from numerous competing firms, and streamlined production lines, causes prices to fall until profit margins can no longer support a growing number of producers. At this point, the market has reached the equilibrium of supply and demand, and the product is now affordable for the greatest number people.

Rich people are incessantly demonized by the envious and the despotic, but consider how our economy would be different if they were suddenly absent. Without rich people, new and expensive products would never be purchased. This would send a signal to potential entrepreneurs and producers that there is little likelihood for a return on their investments, which would seriously hamper the research and development of new products. It is difficult to imagine a world in which the shelves of our stores aren’t constantly being stocked with new products—a world where a better life is just out of reach—but such a world is possible when affluence is erased.

New products are risky. There’s a substantial chance that a new product will fail upon reaching the market. It is thanks to entrepreneurs and producers, who risk their time and resources on ideas, that we have an abundance of ever-improving tools and technology. However, we also owe thanks to the most affluent consumers who help determine if a product is viable. Because they’re willing to take a risk in buying a new product, the rest of us are eventually able to afford a higher standard of living.

The Cost of College

Why state aid is the problem, not the solution

Of all the issues concerning college students these days, few hit closer to home than the issue of college tuition. In a world where a college education–especially a four-year degree–is seen as a bare necessity to compete in the global economy, making a quality education affordable to the most people should be of utmost importance to us as a society. Many people view higher education as something the government should predominantly, if not completely, fund. This sentiment surfaced in Wisconsin with the advent of Governor Walker’s Budget Repair Bill, and prevailed in the discussion surrounding his subsequent biennial budget proposal. Absent from this discussion, however, was a thoughtful inquiry into the root causes of skyrocketing tuition, and the true effects of government aid to public colleges and universities.

For a quick macroeconomics refresher, let us first observe the basic roles of costs and prices in a normal market situation. In a normal market situation, competing firms strategically limit costs and prices in order to attract customers and maximize revenue, which will consequently maximize profit.

This is not the case in the world of higher education, where very few colleges operate under the motivation for profit. In the world of higher education, prices are heavily subsidized by the government. The University of Wisconsin itself derives a hefty amount of financial comfort from this system. Students, just look at your fall semester bill sometime: at the bottom, under “IMPORTANT NOTES” you’ll see a message that says “The Legislature and Governor have authorized $1,001,508,980 of state funds for the University of Wisconsin System and its students during the 2011-2012 academic year. This is a tuition subsidy of $6,418 per student from the taxpayers of Wisconsin.” Because of this, the student is never faced with the true cost of their college experience, and colleges have no incentive to limit costs because they know the government will pay for most of the resulting growth in the price. However: one substantial problem arises from this: Whenever a subsidy shields consumers from the true cost of a product, they tend to overuse the product, and whenever consumers overuse a product, that product will be more costly to produce. Unfortunately, government doesn’t cover all of the new costs incurred by the university, and these costs are passed on to the students. Consequently, we have seen tuition rise far faster than the rate of inflation. According to the College Board, in the last decade alone, tuition at a public four-year college or university has had an average annual growth of 5.6% above the rate of inflation. In fact, it is now 259% more expensive today than it was in 1980, even after adjusting for inflation, and we can see similar trends in both private four-year colleges and public two-year colleges.

This problem is exacerbated by the fact that the assessments of various college accrediting agencies, such as the American Bar Association: Council of the Section of Legal Education and Admissions to the Bar, and the American Dental Association, set academic standards for colleges based primarily on inputs–how much the college spends–and not on outputs, or the individual end result of higher education. This forces even the smallest and most frugal colleges to constantly spend more than they otherwise would, on things they don’t need, simply to gain accreditation. Colleges are also required to periodically publish research in journals and reviews in order to gain accreditation. This diverts resources (professors) from teaching and focuses them on research.

There are two main things we can do to limit the price of college education. First, is simply to stop or severely limit our subsidization of it. Without the promise of massive government funding, colleges would be forced to make more prudent decisions regarding costs, and eliminate waste. If they didn’t, the costs they amass would be too great to sustain because the unsubsidized tuition would prevent students from attending altogether.

Second, we must have accrediting agencies more concerned with the results of education at a specific college, not with how much the college spends. The Secretary of Education is required by law to publish a list of nationally recognized accrediting agencies which are considered reliable in the evaluation of colleges. Any accrediting agency which does not focus primarily the educational outputs of colleges should not be included, and we should not rely on them as a proper gauge of higher education quality.

This doesn’t mean we’d have to sacrifice quality of education either. Colleges could still achieve positive results by finding cost effective ways to deliver education, such as prioritizing teaching over research, providing more flexible hours and classrooms in which professors can teach, and through implementing online teaching technology. College tuition may still rise, but it would rise more gradually, concurrent with inflation.

If we continue to trust the misguided recommendations of accrediting agencies, and if we continue to heavily subsidize our compliance with those recommendations, then we will continue to see a rapid growth in college tuition, as we see today.

Reflections on Free Markets

In contemporary debates on economics, the main contentions usually involve how much government intervention is necessary in the economy. On one side of the debate are the socialists, advocating complete government intervention in the economy, and on the other side are the proponents of free markets, advocating the opposite. Where we find ourselves on that spectrum should depend on an honest discussion about the basic nature of markets.

First, what is a market? Basically, it is a collection of exchanges between people. Markets are most commonly associated with exchanges of goods and services, but they can also exist within other frameworks (e.g., immigration as an exchange of cultures, and universities as exchanges of ideas). In particular, a free market is characterized by voluntary transactions between people. Conversely, when transactions between people are forced or hindered by outside actors, be they governments or other individuals, the market is not free.

In my experience, most criticisms levied against free markets are based on faulty premises. Now that we have some idea of what a free market is, let us take time to address a few examples of what it isn’t:

Free markets and capitalism are not exactly synonymous.

While “capitalism” does traditionally denote a system in which the means of production are owned privately by individuals, that definition does not necessarily provide real insight into the nature of common market transactions. To capitalize merely means acting advantageously upon a situation or opportunity; it is an expression of the innate human desire to maximize personal success. This occurs as much within socialism as it does a free-market, but the differences lie in the particular mode of capitalization used: Maximizing personal success will look different in a socialist economy than in a free market. Nevertheless, it is false to assume that the differences between economic systems will cause differences in human nature.

A free market is also not the same as pure capitalism because pure capitalism involves individuals using any means necessary to advance themselves, including coercive acts, usually referred to as crimes, which abridge other peoples’ natural rights. A free market is, by definition, devoid of coercion (transactions must be voluntary), and is therefore incompatible with pure capitalism. Socialism, on the other hand, has no appreciation for individual rights, so pure capitalism actually comports more nicely with socialism than with a free market!

The free market is not fascism.

I’m not exactly sure where this association comes from, so it’s really hard for me to understand its rational. Fascism is a political philosophy on the left of the political spectrum. Proponents of fascism are hyper-nationalistic and seek to use a powerful government to promote their desires. Much like the other leftist philosophies, such as communism, feudalism, totalitarianism, or monarchism, fascism rejects individual natural rights, and therefore cannot allow the operation of a free market–of goods and services, cultures, or ideas.

The failure of a firm does not denote the failure of a market.

This is another common misconception about free markets. Contrary to popular belief, the failure of a firm is an example of when free markets works best. If a firm is unfit to compete in a market, it goes out of business and its assets are liquidated. This way, markets work out inefficiencies in the system, and the surviving, successful firms are those better equipped to serve the needs of society. Think of markets as an ecosystem, inherent to which is the natural selection for and against competing firms. By removing the weak from the market, the economy evolves and progresses. When government steps in to regulate or hinder this process is when the free market truly fails. The most prominent modern example of this is the recent Wall St. bank bailout. The massive economic bailout for these banks prevented their failure, allowing non-competitive banks to stay in business, insinuating major economic collapse down the road, and all at the taxpayers’ expense.

Now that we’ve defined our terms, the issue resolves to whether or not free markets are beneficial. The propriety of an economic system in which people are able to voluntarily trade with others would seem self-evident, but there are a couple of pertinent criticisms of true free markets which should be addressed.

Externalities

Externalities are a real problem for markets. Externalities are the costs which buyers and sellers within a private transaction unintentionally pass on to the rest of society (e.g, pollution, or traffic congestion). Most economists would concede that externalities are mitigated by institutionalizing these social costs—that is, reintroducing these costs into the immediate transaction and forcing the transaction’s assenting parties to incur it themselves–not society.

Unfortunately, leftists then naïvely assume that government is the best agent, or is the only agent capable of performing this task. They believe that government should tax or regulate businesses and consumers. This will transform the social cost of producing or using a particular product into a direct economic cost incurred by the buyer or the seller, which will decrease either the supply or the demand for the product, and will in turn decrease the product’s social cost.

There are other mechanisms, however, for institutionalizing social costs that don’t require government intervention in the form of confiscatory taxes or regulations. The first mechanism that comes to mind is market self-regulation: If consumers become knowledgeable about the social costs imposed by their demand for a product, they may decide that the benefit derived from a low price is not worth the cost they impose upon the outside world. Firms which self-institutionalize social costs, such as coal power companies investing in scrubbers, or car companies investing in better crash safety technology, may have an easier time marketing their products to the public, as the public may enjoy moral gratification from supporting these companies. As Milton Friedman explains in the video below, tort law and social customs also counteract and guard against market failures.

Monopolies

This is probably the most common honest criticism of markets. The argument goes like this: Every once in a while a firm becomes so large and its operations become so efficient, that it is able to out-compete virtually every other firm in the market. Take Walmart as an example. Walmart is often cited as undercutting the prices of its competitors, taking a short term loss merely to drive its competitors out of business. As the evolutionary processes of the market remove the weak and inefficient firms from the economy, one could expect, in the long run, that only one firm would remain. Logically, it would follow that, in the absence of competition, it would be in the best interest of the one remaining firm to jack up its prices as much as possible, bleeding the consumers dry.

But looking empirically at the issue, this logic simply hasn’t panned out. There is, again, a mechanism built into free markets that protects against this type of occurrence. If Walmart became a monopoly and decided to raise its prices over night, it would make the profitability of potential new firms wanting to enter the market near infinite. As a result, very few monopolies have ever arisen as a result of pure, market-driven forces, and endured for long periods of time. As Milton Friedman explains, most monopolies have endured only because government has intervened on their behalf.

The only two notable examples Friedman mentions of monopolies which have endured without government intervention–the New York Stock Exchange from Reconstruction to the Great Depression, and the De Beers diamond company from the early twentieth century until 2000–both lost their monopolistic status due to the introduction of international competitors. If we are to prevent the emergence and endurance of private monopolies, we must ensure that government policies do not make prohibitive the cost of market entry for competitors, which is exactly what did not happen in the television, steel, labor, railroad, and trucking markets.

Conclusion

Free markets are a fact of life–they are not implemented, but rather exist by default. Free markets are imperfect, though, because people are imperfect, and no private or public system comprised of people will ever be without flaw. However, a free market is the most efficient economic system ever known to mankind. Even with the presence of externalities and occasional monopolies, free markets succeed in producing the greatest amount of wealth for the greatest number of people. Most importantly, free markets reflect human nature, and the cause to better oneself. They are an expression of individual natural rights, and they yield a net benefit for society as a whole.