How Network Neutrality Promotes Innovation

As I've pointed out many times in previous posts, one of the key benefits of mandating network neutrality is that it promotes innovation by creating a level playing field. Such statements are all very well, but where's the evidence? An...


As I've pointed out many times in previous posts, one of the key benefits of mandating network neutrality is that it promotes innovation by creating a level playing field. Such statements are all very well, but where's the evidence? An important new study entitled "The innovation-enhancing effects of network neutrality" [.pdf], commissioned by the Dutch Ministry of Economic Affairs from the independent SEO Economic Research unit provides perhaps the best survey and analysis of why indeed network neutrality is so beneficial:

The Ministry of Economic Affairs asked SEO Economic Research to describe what the essential economic mechanisms are through which network neutrality fosters innovations by new and small innovators. The results presented in this study are based on desk research, primarily on findings in the blooming economic literature on network neutrality.

Here's the central result:

Traffic management in best-effort routing, such as payments for priority lanes and blocking competing services and applications, reduces competition between ISPs and increases the entry barriers for CAPs [content and application providers], in particular for small CAPs.

Here's one reason why:

First, an ISP has incentives to reduce competition by differentiating itself from other ISPs by offering priority lanes only for certain large content and application providers, with which other ISPs do not contract. Other ISPs have the same incentives. Through prioritization, ISPs can avoid the commodity trap – the internet as a homogenous product – and charge higher connection fees to end-users. A lower level of competition reduces innovation incentives of ISPs because they do not need to compete for end-users by innovative services.

Here's another:

Second, paying for priority lanes or facing anticompetitive practices of ISPs increases the market entry costs for CAPs. These costs discourage innovations by both new – as they do not enter the market – and incumbent CAPs. Network neutrality helps eliminate these market imperfections and hence increase competition between ISPs and the innovation activity of both ISPs and CAPs.

In other words, there is a double benefit from net neutrality, both in terms of stimulating ISP competiton, and for content and application producers. But the study points out that there is another, more indirect advantage that involves a complex interaction between CAPs, end-users and ISPs, all of whom gain thanks to network neutrality:

Network neutrality also stimulates connectivity between end-users and CAPs. On the one hand, more end-users connect to the internet because of innovations mainly by small CAPs. On the other hand, larger connectivity makes providing innovative content and applications more attractive for both small and large CAPs as they convert the benefits from connectivity (so-called network externalities) into financial benefits. More specifically, connectivity represents economic value for CAPs directly as they can achieve higher revenues from direct payments. Moreover, CAPs benefit indirectly through more advertising revenues as their services become more attractive for advertisers. On top of this, the value of the internet connection itself increases for end-users as they get access to more content and applications. Therefore, they are willing to pay more for an internet connection and, as a consequence, ISPs also benefit from larger connectivity, which fosters the innovation.

The report rightly notes that all of today's Internet giants – Google, Facebook etc. - started as tiny startups. As such, they were able to build on existing net neutrality to offer their services unhindered by discriminatory moves by incumbents. Rather hypocritically, many of them wish now to destroy net neutrality in order to increase the barrier to entry for new startups that might threaten their revenues and profits. But as the latest research notes, even they would benefit from maintaining and safeguarding net neutrality:

network neutrality has some positive effects on their innovation incentives as it avoids costs of prioritization. First, if buying a priority lane is beneficial for a CAP, it needs to negotiate and contract with several ISPs, which process entails large transaction costs that are absent under network neutrality. Second, network neutrality helps avoid other types of market inefficiencies, such as the overcharging by ISPs and the overuse of network capacity as several (or even all) large CAPs have incentives to buy priority

The main body of the report fleshes out these ideas, providing all the necessary references for those who wish to explore the evidence further, which is one reason why I think this is a very valuable contribution to the debate about net neutrality. It would be really great if European politicians involved in policy-making in this area read it before making any ill-considered decisions that could have a hugely negative impact on future innovation in the European Union. But I'm not holding my breath...

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