The Economics of Network Neutrality

By Nicholas Economides

Posted on February 28, 2012

The Economics of Network Neutrality, forthcoming at the RAND Journal of Economics, co-authored by Professors Nicholas Economides of New York University’s Stern School of Business, and Benjamin Hermalin of the University of California at Berkeley’s Haas School of Business, discusses the private and social benefits of allowing Internet Service Providers (ISPs), such as the telephone or cable companies, to charge content and application providers (e.g. Disney, Google, Microsoft, Netflix) for access to the ISPs’ residential customers.

Network neutrality is defined as an open, neutral system free of fees to content or applications providers on the Internet. Starting in 2005, AT&T and other ISPs proposed to start charging content/application providers to allow them to reach consumers’ homes. These charges would be over and above what residential users pay the ISPs, and what normally content/application providers pay for Internet transport. Additionally, ISPs proposed charging content/application providers for priority in delivering their content, with non-paying parties relegated to the slow lane. Even though long distance transport on the Internet backbone is competitive, there is limited competition among ISPs for residential users at each location. Therefore residential ISPs are not constrained by competition in violating network neutrality. The Federal Communications Commission (FCC) adopted network neutrality rules in December 2010, but these have been challenged in court by Verizon.

This article shows that, for a wide class of utility functions (preferences of users), even if networks are congested, it is optimal for society to adopt a network neutrality rule imposing no prioritization and no fees to content/application providers. This is essentially because, when you allow a certain application/content provider, such as Hulu, access to a fast lane, people are going to use it more, increasing congestion in the fast lane. This diminishes the benefits to society from creating fast lanes. Even though society as a whole is better off with network neutrality rules, the residential ISP is better off without them, hence the conflict between telecom and cable providers on one side and the FCC on the other, representing the public. The authors also examine the incentives of investment in bandwidth with and without network neutrality.

This article assumes that ISPs do not provide their own content. If an ISP sells its own content (as many do), this creates an additional incentive for the ISP to prioritize its own content and violate network neutrality.
The research strongly supports a network neutrality regulation as adopted by the FCC.