The Economics Of California’s Net Neutrality Law

Many policy proposals sound great on the surface, but when viewed from economic and empirical perspectives suggest sup-optimal results. One example is net neutrality or open internet, which I have studied using network traffic analysis for more than a decade across 50 countries. The data show mixed results for the policy; countries with soft measures like transparency and disclosure get better results than those with hard core price controls as proposed by California. A recent court decision greenlights the imposition of the California Internet Consumer Protection and Net Neutrality Act of 2018 (CA SB-822). Here’s a brief review of its economics.

The bill asserts that California is dependent on an open and neutral internet for the following nine “vital functions” to work:

(A) Police and emergency services.

(B) Health and safety services and infrastructure.

(C) Utility services and infrastructure.

(D) Transportation infrastructure and services, and the expansion of zero- and low-emission transportation options.

(E) Government services, voting, and democratic decisionmaking processes.

(F) Education.

(G) Business and economic activity.

(H) Environmental monitoring and protection, and achievement of state environmental goals.

(I) Land use regulation.

The bill makes an interesting assertion that is contradicted by the fact that these functions have been working without SB-822 in effect. These functions also work in every other state without such rules. My forthcoming study of four fiber to the home networks shows that 8 of the 9 vital functions use only 25 percent of the bandwidth on a network. One subset of the business function, streaming video entertainment from Netflix, YouTube, Disney+/Hulu, Microsoft/Xbox and Amazon Prime, uses 75 percent of the network bandwidth, and this amount is increasing.

Policy norms have dictated that fixed line broadband access is offered on commoditized or flat-rate access, and net neutrality rules enshrine this. However, this model falls hardest on people with low-income, particularly immigrants, and those in rural areas. About two-thirds of American households subscribe to one or more streaming video entertainment services, paying fees of up to $25 on top of the price of flat rate broadband. Enabling the provision of video streaming entertainment requires a continuous investment in equipment and energy in the middle mile of networks. In my study, the investment amounts to $17 per subscriber per month. However, broadband providers have difficulty to recover this cost equitably. Following the net neutrality logic, the upgrade cost is imposed on all network subscribers, even if they don’t subscribe to Netflix. This means that everyone is paying an additional $10 per month in video streaming cost. But those who watch a lot of movies get a 60 percent discount.

It’s no surprise that net neutrality has been litigated for some decades as it amounts to taking of property without just compensation. The recent court ruling will probably be appealed, as it likely violates a Constitutional tenet that California can’t regulate services from other states. Moreover, the California net neutrality law violates the speech rights of end users.

The premise of the legislation to prohibit blocking of content and services seems defensible. But this also obliges end users to pay for content they don’t necessarily want, like advertising. For example users watch ad-supported YouTube with embedded video ads. While these ad formats have improved in efficiency, video ads can consume significant bandwidth for which the consumer must pay. In a fair market, the advertiser would pay for the bandwidth to deliver the ad. But net neutrality makes this practice illegal. Essentially California says that end users must pay 100% of the broadband cost while the internet advertising pay zero.

SB-822 also prohibits “zero rating” and “paid prioritization.” These are common pricing practices for many goods and services, for example an overnight shipment via FedEx, the free trial at the gym, a free dessert with the purchase of an entree and so on. Tesla’s cars come with a sim card that zero-rates Spotify. Bundling makes sense to stimulate the use of connected devices and smart services, but the practice will be killed by SB-822. If California’s politicians really cared about “vital functions”, they’d support the “zero rate” on socially valuable services (let them be free or low-cost) but flexibly price the privately valuable ones like entertainment which varies with personal preference.

Historically the notion of using one’s your internet connection to access legal content with a legal device has not been controversial. In fact, broadband providers have already agreed to uphold this and have been required to do this as part of consent decrees. However it’s not clear how California’s policy will work if House Democrats demand that cable companies block legal content from FoxNews, OneAmerica News Network, Newsmax and others. This hypocrisy leads many to be skeptical of net neutrality, seeing it instead as government censorship.  

Advocates claim that heavy-handed regulation is needed to stop broadband providers from blocking content and services, but over 20 years, this has happened in only a handful of small cases. Meanwhile, the big tech platforms block, ban, throttle, and demonetize the content and users they don’t like every day. Demanding neutrality for just one part of the internet is illogical. Consumers deserve the same rights and protections across the internet. Congress has to power to set this right, and it should.

(H) Environmental monitoring and protection, and achievement of state environmental goals.

(I) Land use regulation.

The bill makes an interesting assertion that is contradicted by the fact that these functions have been working without SB-822 in effect. These functions also work in every other state without such rules. My forthcoming study of four fiber to the home networks shows that 8 of the 9 vital functions use only 25 percent of the bandwidth on a network. One subset of the business function, streaming video entertainment from Netflix, YouTube, Disney+/Hulu, Microsoft/Xbox and Amazon Prime, uses 75 percent of the network bandwidth, and this amount is increasing.

Policy norms have dictated that fixed line broadband access is offered on commoditized or flat-rate access, and net neutrality rules enshrine this. However, this model falls hardest on people with low-income, particularly immigrants, and those in rural areas. About two-thirds of American households subscribe to one or more streaming video entertainment services, paying fees of up to $25 on top of the price of flat rate broadband. Enabling the provision of video streaming entertainment requires a continuous investment in equipment and energy in the middle mile of networks. In my study, the investment amounts to $17 per subscriber per month. However, broadband providers have difficulty to recover this cost equitably. Following the net neutrality logic, the upgrade cost is imposed on all network subscribers, even if they don’t subscribe to Netflix. This means that everyone is paying an additional $10 per month in video streaming cost. But those who watch a lot of movies get a 60 percent discount.

It’s no surprise that net neutrality has been litigated for some decades as it amounts to taking of property without just compensation. The recent court ruling will probably be appealed, as it likely violates a Constitutional tenet that California can’t regulate services from other states. Moreover, the California net neutrality law violates the speech rights of end users.

The premise of the legislation to prohibit blocking of content and services seems defensible. But this also obliges end users to pay for content they don’t necessarily want, like advertising. For example users watch ad-supported YouTube with embedded video ads. While these ad formats have improved in efficiency, video ads can consume significant bandwidth for which the consumer must pay. In a fair market, the advertiser would pay for the bandwidth to deliver the ad. But net neutrality makes this practice illegal. Essentially California says that end users must pay 100% of the broadband cost while the internet advertising pay zero.

SB-822 also prohibits “zero rating” and “paid prioritization.” These are common pricing practices for many goods and services, for example an overnight shipment via FedEx, the free trial at the gym, a free dessert with the purchase of an entree and so on. Tesla’s cars come with a sim card that zero-rates Spotify. Bundling makes sense to stimulate the use of connected devices and smart services, but the practice will be killed by SB-822. If California’s politicians really cared about “vital functions”, they’d support the “zero rate” on socially valuable services (let them be free or low-cost) but flexibly price the privately valuable ones like entertainment which varies with personal preference.

Historically the notion of using one’s your internet connection to access legal content with a legal device has not been controversial. In fact, broadband providers have already agreed to uphold this and have been required to do this as part of consent decrees. However it’s not clear how California’s policy will work if House Democrats demand that cable companies block legal content from FoxNews, OneAmerica News Network, Newsmax and others. This hypocrisy leads many to be skeptical of net neutrality, seeing it instead as government censorship.  

Advocates claim that heavy-handed regulation is needed to stop broadband providers from blocking content and services, but over 20 years, this has happened in only a handful of small cases. Meanwhile, the big tech platforms block, ban, throttle, and demonetize the content and users they don’t like every day. Demanding neutrality for just one part of the internet is illogical. Consumers deserve the same rights and protections across the internet. Congress has to power to set this right, and it should.

Originally published in Forbes.