Towards an Economic Framework for Network Neutrality Regulation

Over the past years, the merits of network neutrality regulation have become a hot topic in telecommunications policy debates. Repeatedly, proponents of network neutrality regulation have asked the Federal Communications Commission to impose rules on the operators of broadband access networks that forbid network operators to discriminate against third-party applications, content or portals (“independent applications”) and to exclude them from their network. These proposals are based on the concern that in the absence of such regulation, network operators may discriminate against these products and that this behavior may reduce innovation by providers of these products to the detriment of society.

Opponents of regulation deny the need for network neutrality regulation. They argue that regulation is not necessary because network operators do not have an incentive to discriminate against independent applications anyway, or, alternatively, that regulation is harmful because it would reduce network operators’ incentive to upgrade their networks in the future.

This paper aims at assessing the economic merits of network neutrality regulation. To this aim, the paper applies insights from game theory, industrial organization, antitrust, evolutionary economics and management strategy to analyze network operators’ incentives to discriminate, the impact of potential discriminatory behavior on innovation and social welfare, and the costs of regulation.

The results of the paper advance the debate over network neutrality in a number of ways: Economic theory predicts that a network operator that has a monopoly in the market for Internet services does not generally have an incentive to discriminate against independent applications. There are known exceptions to this rule, but there is considerable debate over whether these apply in the Internet context. The paper shows that some of these exceptions may indeed apply in the context of the Internet. More importantly, it identifies exceptions that have not been previously thought of. Thus, there are more cases in which a network provider may have an incentive to discriminate than is commonly assumed.

Researchers commonly assume that discrimination against an application will only be profitable, if the network operator manages to monopolize the market for the application in question. The paper shows that this assumption is not correct. A network operator may have an incentive to discriminate against an application even if the operator does not manage to drive independent applications from the market. As a result, researchers commonly underestimate the potential for discriminatory behavior by network providers.

Participants in the debate usually share the view that competition in the market for Internet services may be able to mitigate the problem. Two policy proposals, the proposals for facilities-based competition and for open access, are based on this view. The results of the paper contradict this view. The paper highlights a variety of circumstances under which a network operator may have the ability and incentive to discriminate against independent applications in spite of competition in the market for Internet services.

Finally, the paper shows that the threat of discrimination will reduce the amount of application-level innovation to the detriment of society as a whole.