Internet Economics + Regulating Technology I Spring 2007 February 27

Today The emerging role of the Internet in economic growth Internet business models Regulating Internet infrastructure “Net Neutrality” Today

Markets are central to economic processes

When might we need government? Market failures: externalities, public goods, monopoly, imperfect information

Economic Development 1.0 Capital Output Labor Technology

Economic Development 2.0 Physical capital Output Labor Technology Human capital

Economic Development 2.x Civic organizations & institutions Governance Economic Development Innovation & Productivity

Civic organizations & institutions Governance Economic Development Innovation & Productivity Information Technology & Communication Economic Development – the Role of ICT

Transactions Costs Ronald Coase “The nature of the firm” 1937 Transactions costs influence the structure of production, firms and markets Transactions costs Search costs and information costs Bargaining and contracting costs Policing and enforcement costs Protecting trade secrets

Institutions Douglass North – the ‘rules of the game’ Institutions reduce transactions costs Institutions include the rule of law, property rights, social norms, …

Anonymity LAW MARKETNORMS ARCHITECTURE

Anonymity LAW MARKETNORMS ARCHITECTURE

Anonymity LAW MARKETNORMS ARCHITECTURE

What are the most important stories in Internet business and economics?

Amazon eBay Google – Yahoo iTunes Wikipedia Craig’s list Outsourcing Syndication Aggregation Open source

New models or more competitive? Internet = falling transactions costs Particularly for information services and knowledge Internet = lower costs of information How much is delivering new products and services and how much is displacing existing businesses? Are the institutions changing as well?

Internet Business Models

The Long Tail

Long Tail Sale of less popular products is now a larger part of total sales Lower search costs = more available for more people Lower inventory and distribution costs make it becomes profitable to sell a wider variety Netflix vs. the video rental store Amazon vs. the bookstore What is the net result: new mega-corporations or support for small producers?

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Friedman The World is Flat Supply chains that stretch across oceans Outsourcing – technical support, software engineers, tax preparation, the presentation for your meeting, McDonald’s, JetBlue, and so on… Globalization is here – deal with it

Internet & Globalization Internet has helped to spur on globalization Cost of distributed production has dropped Less need for locating labor close to product sales and servicing Lower information costs create new production, trade and management alternatives Effective aggregators of low cost producers Technology transfer Walmart & the supply chain

Globalization II Higher growth + economic development Correlated with reduced job security Disruption, uncertainty and adjustment costs Decline in local economies Winners and losers

Market failures Public goods Imperfect information Monopoly Externalities - spillovers

Network effects Network effects = positive externalities = spillovers ~= public goods Reed’s law – networks scale exponentially Interoperability Path dependency & lock-in Barriers to entry and competition Fax machine; IM; Windows; Wikipedia; markets

Defining Public Goods ExcludableNon-excludable RivalSushiFishery Non-rivalCable TV Copyrighted work Public defense Ideas

Internet: Public or Private? ExcludableNon-excludable Rival Non-rival

Internet: Public or Private? ExcludableNon-excludable Rival Internet infrastructure Spectrum 1960 Internet infrastructure Non-rival Internet infrastructure Applications Spectrum 2007 Information – copyrights Information F/OSS

Typology of Infrastructure Commercial infrastructure Non-rival/partially rival Input into production of private goods Public infrastructure Non-rival/partially rival Input into production of public goods Social infrastructure Non-rival/partially rival Input into production of non-market goods

Typology of Infrastructure Commercial infrastructureManufacturing Cable TV Roads Internet Public infrastructureBasic research Ideas/knowledge Internet Social infrastructureLakes Roads Internet

Monopoly Economies of scale High fixed costs Low variable costs Falling costs of production Choices: Private production without regulation Private production with regulation Public production

So what should we do about it? Is there a role for government? Telecommunications policy

Three eras of communication: (i) Over-the-air Localism, Diversity, Universalism (ii) Cable Relationship between cable and over-the-air (iii) Internet Innovation, competition, democracy

Radio Act of 1927 SEC. 11. If upon examination of any application for a station license or for the renewal or modification of a station license the licensing authority shall determine that public interest, convenience, or necessity would be served by the granting thereof, it shall authorize the issuance, renewal, or modification thereof in accordance with said finding.

Public Interest in the Broadcast Age (a) Trusteeship model with commercial broadcasters (b) Public Broadcasting Service and Corporation for Public Broadcasting (c) Public, Educational, Government (PEG) Access Channels

A Fundamental Shift Scarcity to Competition

(1982) Regulatory Failure

Telecommunications Act of 1996 Deregulatory, in the hope of fostering competition

Market Failure

A Fundamental Shift One-to-Many to Many-to-Many

Public Interest Media in the Internet Age “Today our problem is not making miracles--but managing miracles. We might well ponder a different question: What hath man wrought--and how will man use his inventions?”

“Generativity”

“Neutrality” “Discrimination” Red Herrings and Straw Men Rhetoric

Framers’ Intent? Bob Kahn: Network Neutrality is a dogmatic slogan that means: "nothing interesting can happen inside the net" Vint Cerf: On discriminatory techniques: “I’m worried that such a business model will seriously impair innovation in the network”

Mapping the Neutrality Debate The Telecom/Cable Position How do we incentivize investment & innovation? Antitrust (ex post) A possible market-power oriented solution? Regulation (ex ante) Should we trust antitrust?

“Four Internet Freedoms” access the lawful Internet content of their choice run applications and services of their choice, subject to the needs of law enforcement connect their choice of legal devices that do not harm the network competition among network providers, application and service providers, and content providers (“Although the Commission did not adopt rules in this regard, it will incorporate these principles into its ongoing policymaking activities. All of these principles are subject to reasonable network management.”) consumers are entitled to…

Sample Legislation

Verizon Position regulation categorically fails

Nondescrimination regulation would be a new imposition Competition exists and is fierce

Antitrust (ex post) Madison River and Vonage Could rely on market definitions Designed to solve problems only when they occur

Should We Trust Antitrust? Is it effective? Can it be clear enough? Does it capture the public interest?

Regulatory Approaches (ex ante) Vertical, and the legacy of common-carrier Layer-based models Wu’s proposal

Internet economics How to monetize the distribution of information? Managing intellectual property rights eCommerce

New Internet economics Leveraging information for human and economic development Forming new institutions for growth and better governance Peer production Innovation commons

Take Home Falling transactions costs and lower prices create new markets and production possibilities Big changes means big winners and losers Key question is how to address issues of public goods Institutions including property rights play a key role in economic growth. There are many avenues towards innovation. Should policy favor one over the other?

Institutional change Technological change is rapid Changing technology can undermine existing institutions Institutional change has historically been slow