Tuesday, November 18, 2014

If only President Obama had read Chapter 5

It looks as if the President failed to anticipate the consequences of his "net neutrality" policy.  After the White House "offered a full-throated endorsement “for the strongest possible rules” in support of “net neutrality,” AT&T CEO Randall Stephenson said that his company was going to step back from investing billions of dollars in building out its own GiGaPower fiber network:

Stephenson clearly fears that the President’s call to the FCC will result in heavy new regulations that will reduce the profit potential of the company. AT&T is holding back to see just how badly the new rules will damage its investment prospects.
Some economists found the President's analysis short-sighted:
The President defends this supposed pillar of the Internet policy by insisting that “an entrepreneur's fledgling company should have the same chance to succeed as established corporations, and that access to a high school student's blog shouldn't be unfairly slowed down to make way for advertisers with more money.” 
But why should this be the case when paid prioritization is the norm in virtually all highly competitive markets? A quick trip to the Federal Express website, for example, reveals a wide range of “fast and full of options” like “FedEx Priority Overnight and FedEx Standard Overnight.” There is also two- or three-day shipping and Saturday service for those who want it. The different tiers of services are offered, not surprisingly, at different rates. These differential services are available to all customers. It is simply wrong for the President to assume that any system of paid prioritization entrenches established companies at the expense of new entrants, or greedy advertisers at the expense of high-school bloggers.
If President Obama had read Chapter 5, he would have known to "look ahead and reason back."  Don't worry though, I sent him a copy of the third edition 


  1. As someone in the IT field who has been watching AT&T stifle broadband roll-out for years, I can only roll my eyes... They promised my parents DSL "in a few months" 15 years ago, and have yet to deliver. So allow me to translate AT&T's latest press release into simple English:

    "We are going to stop doing that thing that we've been promising for years that we were gonna get around to doing one of these days, but never actually started doing, because OBAMA".

    Adding "Obama" to any argument is the modern-day equivalent of the "Chewbacca Defense". It makes people ignore the facts of the case, and only react emotionally. AT&T are hoping people will ignore the fact that the have been paid by taxpayers to roll out a fiber network, yet failed to do so, and our nation's broadband infrastructure is currently rated below most of the former Soviet bloc.


    You cannot measure AT&T's intent by number of their press releases, but by their actual actions.

    The fundamental problem is misaligned incentives. What happens to be in AT&T stockholder's best interest (extracting equity-like monopoly rents by treating old twisted-pair wiring as a cash cow, rather than investing in modern fiber infrastructure) is contrary to society's best interest (having fast, modern broadband infrastructure widely available).

    The problem is compounded by regulatory capture at all levels of government. As Chattanooga, Tullahoma, and Clarksville have shown, municipalities and electric co-ops can provide equal service at lower prices than commercial ISP's, in part due to charging their customers more proportionately to the actual cost of providing service (if reward is proportional to risk, and you're a monopoly, shouldn't you expect debt-like returns instead of equity-like returns since you have lower risk?), and in part due lower overhead (sharing infrastructure and only needing one cable to provide both fiber and power).

    Commercial ISP's didn't like this at all, and, after increasing donations to politicians by a factor of 100 in 2008, the TN legislature passed a bill forbidding municipalities and electric co-ops from issuing debt to fund the roll-out of broadband to their constituents. You can imagine how hobbled our economy would be if the legislature banned CEMC from borrowing to roll out electric lines in the 1930's. They got their competition banned in the name of increasing competition, by promising legislators they would accelerate their roll-out of broadband, but failed to do so, and our elected officials, cash in hand, had little reason to call them on it.

    Broadband internet is a textbook example of a natural monopoly. Just like water, sewer, natural gas, electricity, etc. And government serves the public interest in regulating a natural monopoly, whether as a government-owned monopoly or a publicly-regulated private utility. I am a (r)epublican, and when Obama says that broadband needs to be regulated, it is simply calling a spade a spade.

    1. OK, if broadband internet is a natural monopoly, and the problem is under-deployment, how do we get it deployed? By the government? Do they have the right information or incentives to choose the right technology? Remember France's Minitel?

    2. A simplification, but hopefully accurate enough to state the problem...

      Since 2008, we have a) a serious need for a modern Internet infrastructure, b) unemployed blue-collar workers who are qualified to pull fiber, install poles, dig trenches, etc., and c) a quantity of savings which can't find sufficient investment opportunities even at near 0% interest rates.

      In a normal world where the economy isn't against the zero-bound, government borrowing can "crowd out" borrowing by consumers and businesses, and should be restrained. But at the zero bound, pretty much by definition, the supply of savings exceeds the investment demand for those savings. In that situation (which has only occurred twice in the past century), government does the economy a favor by serving as the borrower of last resort.

      If government can borrow for nothing (indeed, for a while there was *negative* real interest rate on government debt, so people were *paying* government to hold their money), put unemployed workers back to work (vs paying them unemployment to do sit around doing nothing), and roll out a modern broadband infrastructure that will yield financial and social returns for decades (I don't doubt that my grandchildren will still be using fiber), that's seems like a no-brainer to me.

      Most of the cost of a fiber infrastructure is simply the manpower and machinery required to pull, hang, and bury the fiber. The cost of electronics is a rounding error in comparison. There's little way to "choose" the wrong fiber.

      AT&T could do this themselves, but don't. Their shareholders (very rationally) want to own a low-risk monopoly generating equity-like returns. Thus they are treating their "sunk cost" copper networks like cash cows because the only competition they have is themselves. And a dollar spent on fiber is a dollar less for shareholders. AT&T is scared by Google Fiber and is making some noise, but if you compare words with actions, AT&T is disregarded by most tech folks as having "fiber to the press release" rather than concrete plans.

      Government could fund broadband via "public" channels by funding municipalities/electric co-ops to provide internet to their constituents if private ISPs won't. Or they could use "private" channels by compelling ISPs to roll out the service and underwriting the private debt required to do so. Both approaches have trade-offs. Either is better than the status quo.

    3. As a physicist, I understand "paradoxes". They occur throughout physics where a simple rule breaks down, and requires a more fundamental law to explain phenomena. Black holes and the CPU in your computer are "paradoxical" by the laws of classical physics because understanding them requires a more fundamental law of physics (general relativity, quantum mechanics) than Newton's and Maxwell's laws. So I have very little problem believing the "paradox of thrift", "paradox of toil", etc. are valid explanations of economic reality in certain circumstances (like an economy against the zero bound).

      Sadly that's not how Washington DC works, due to (IMHO) a noxious mix of misaligned incentives (both ideological and financial) and "sincere ignorance and conscientious stupidity". At the zero-bound, fiscal stimulus should have been preferred over quantitative easing because it puts money back in the hands of the most debt-constrained actors (ie, poor people), whereas QE rewards the wealthy at the expense of the poor, worsening inequality and increasing asset inflation.

      Inequality is a hot topic among economists. I don't understand every subtlety. But there is "correlation if not yet causation" between the extreme inequality in 1929 and 2008 and the subsequent depressions. By failing to invest in infrastructure, not only did we not get a nice shiny new internet, we further inflamed inequality, which (IMHO) substantially increases the likelihood of further depressions and/or Larry Summer's "secular stagnation" thesis coming to pass.

      France's Minitel was an information service, not a physical network. Comparing Minitel to fiber is about as "apples and oranges" as trying to compare cheap Asian electronics with the electric grid that powers them. If Samsung burns me, I'll use Sony. If Minitel burns me, I'll use Compuserve, AOL, or not use Minitel at all. If AT&T burns me, judging by the past 15 years, there's nothing I can do about it. Though I hope that's changing.

  2. I take offense at "But why should this be the case when paid prioritization is the norm in virtually all highly competitive markets?"

    Yes, there are multiple broadband providers - AT&T, CenturyLink, and so on. However, in a given geographic area, or "market", there's a multitude of studies that demonstrate that consumer choice is fantastically limited.

    The UPS/FedEx analogy only exists because a given consumer wishing to send a package has many options - DHL, UPS, USPS, FedEx, etc. However, when consumer choice is limited because I only have one, maybe two, broadband providers available to me, then there are no controls on how/whether providers will distribute their price increases.

  3. This is a very interesting topic to me since I work in the telecommunications business. The underlying issue is that the communications has involved into something more complex then the once simple rotary phone. The government is now viewing the evolution of communications differently, as it was once less involved with these areas, and believes it should be more engaged and treats it as is does with most utilities. In my opinion, cell phones and data have become another utility to individuals, it is just as important as water, gas, & electricity as this has become more of need as oppose to a luxury. For example, I need data or network capacity in order to do my school work or every day job. Even though the government may make it difficult or costly for companies to build these areas out, I believe these companies will still make the necessary profitability in the long run. I’m looking at this from the prospective in that would it be fair for large companies to purchase water supplies at larger quantity quicker than the average household, just because they can afford it. Should I have to take a shower with water that drips out of the shower head, because I need to pay for it to get faster to the house?

  4. While not experienced in the Nashville political race for mayor, I applaud David Fox for proclaiming fiscal responsibility. Governmental agencies at all levels do not want to address the harsh realities that many businesses face every day.

    Businesses have to generate a profit and a cash flow in order to sustain operations and existence. For government, they are not required to be profitable and are able to raise revenue by increasing taxes or fees without feeling the effects of price elasticity. Taxpayers do not have the ability to simply use another municipality or agency for most services. They can vote officials out-of-office, so officials try to minimize that risk by not pushing for unpopular actions.

    At the federal level, Congress and the President has failed to reduce our national debt and deliver consistent balanced budgets, because they do not want to cut spending and effect votes. The reality is that taxes and revenues cannot be raised enough to cover all spending that government wants.

    At the federal, state, and local levels government gives increasing benefits without offsetting revenues by borrowing funds. Borrowing for capital projects can be acceptable as the taxpayers pays off the loan and interest while they enjoy the benefit during the projects life.

    Governments should not engage in arbitrage opportunity as a revenue source as the risk is beyond acceptable levels, especially in terms of pension funds. In 2008, almost every pension fund took substantial losses when the S & P 500 lost over 38.5% of its value. Imagine if the Kansas Pension Fund had borrowed funds at 5% and then lost over 38.5 % of the assets. Kansas should address the problem by freezing future benefit increases, raising taxes to allow for increased contributions, and cut expenditures in other areas. Pension plans do not need to be funded in a single year, but a 7-10 year plan needs to be developed, communicated and implemented despite the political fallout (Stanton 2008).

    Karen Whelpley

    Work Cited
    Froeb, L., McCann, B., Shor, M. and Ward M. (2014). Managerial Economics: A Problem Solving
    Approach. (Third Edition). Mason: South-Western Cengage Learning.

    Stanton, E. (December 31, 2008). U.S. Stocks Post Steepest Yearly Decline Since Great Depression. Web. (February 17, 2015). Retrieved from:

  5. The title for this post caught my attention and although completely unrelated, the comments remind me of one of my favorite brands. Schwinn the iconic bicycle brand was sunk due to poor investment decisions, poor operational decisions and the reduction of import restrictions on foreign imports. After decades of market domination the company sunk, as a result less dominant brands passed Schwinn by; offering quality bicycles at more reasonable prices. It is a saga of spectacular failure. Of management blunders that stretched across the globe. Of vengeance wreaked by former executives and Asian suppliers. Of a family’s insistence on retaining control and rejecting outside capital until it was too late. Of two corporate cultures- good old boys living in the past, MBAs flow-charting the future- clashing while competitors pass them by (Crown and Coleman, 1993).The story is simple, the family owned company wanted to remain in complete control and they wanted to remain in the US. Unfortunately a slew of poor decisions over the course of decades proved too big to recover from. Schwinn simply opted not to keep up with the times and failed to invest in technological upgrades at its manufacturing plants, they opted not to use the newest materials or the latest techniques. They simply kept rolling along as if the world was not passing them by. When competitors were moving manufacturing off shore to cut costs the company sat idle, refusing to do the same. They actually opted to open another US based plant which failed miserably, losing more than $30 million over 10 years.
    Had the family opted to upgrade the US manufacturing plants or to offshore manufacturing altogether who knows what could have happened. The brand is iconic and is still a household name in the US, but sadly the brand is not it what it used to be. The Schwinn Shop was once a staple on every Main Street in America, now the bicycles are sold on the floors of the discount giants and the quality is poor at best. All investment decisions involve trade-off between current sacrifice and future gain. Before investing, you need to know whether the future benefits are bigger than the future costs (Froeb ET all, pg . 51 2014).
    Crown, Judith & Coleman Glenn. October 9, 1993 “The Fall of Schwinn” retrieved on October 4, 2015 from www.chicagobusiness.com
    Froeb, L.M., McCann, B.T., Ward, M.R. & Shor, M. (2014). Managerial Economics: A Problem Solving Approach. Mason, Ohio: Southwestern Cengage Learning.