As a result of their investment to create next-generation broadband networks, network operators have the ability to innovate inside the network by offering both senders and receivers of information greater bandwidth and prioritization of delivery. Network neutrality regulation would, among other things, prevent providers of broadband Internet access service (such as digital subscriber line (DSL) or cable modem service) from offering a guaranteed, expedited delivery speed in return for the payment of a fee.

The practical effect of banning such differential pricing (called “access tiering” by its critics) would be to prevent the pricing of access to content or applications providers according to priority of delivery. To the extent that an advertiser of a good or service would be willing to contract with a network operator for advertising space on the network operator's affiliated content, another practical effect of network neutrality regulation would be to erect a barrier to vertical integration of network operators into advertising-based business models that could supplement or replace revenues earned from their existing usage-based business models.

Moreover, by making end-users pay for the full cost of broadband access, network neutrality regulation would deny broadband access to the large number of consumers who would not be able to afford, or who would not have a willingness to pay for, what would otherwise be less expensive access. For example, Google is planning to offer broadband access to end-users for free in San Francisco by charging other content providers for advertising. This product offering is evidently predicated on the belief that many end-users demand discounted or free broadband access that is paid for by parties other than themselves.

Proponents of network neutrality regulation argue that such restrictions on the pricing policies of network operators are necessary to preserve innovation on the edges of the network, as opposed to innovation within the network. However, recognizing that network congestion and real-time applications demand some differential pricing according to bandwidth or priority, proponents of network neutrality regulation would allow broadband Internet access providers to charge higher prices to end-users (but not content or applications providers) who consume more bandwidth or who seek priority delivery of certain traffic.

Thus, the debate over network neutrality is essentially a debate over how best to finance the construction and maintenance of a broadband network in a two-sided market in which senders and receivers have additive demand for the delivery of a given piece of information - and hence additive willingness to pay. Well-established tools of Ramsey pricing from regulatory economics can shed light on whether network congestion and recovery of sunk investment in infrastructure are best addressed by charging providers of content and applications, broadband users, or both for expedited delivery.

Apart from this pricing problem, an analytically simpler component of proposed network neutrality regulation would prohibit a network operator from denying its users access to certain websites and Internet applications, such as voice over Internet protocol (VoIP). Although some instances of blocking of VoIP have been reported, such conduct is not a serious risk to competition. To address this concern, I analyze whether market forces (that is, competition among access providers) and existing regulatory structures are sufficient to protect broadband users. I conclude that economic welfare would be maximized by allowing access providers to differentiate services vis-à-vis providers of content and applications in value-enhancing ways and by relying on existing legal regimes to protect consumers against the exercise of market power, should it exist.

The above article is posted on the Social Science Research Network (SSRN) and may be freely downloaded at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=928582