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David Brodwin's blog

The Universal Internet

This month, President Barack Obama urged the Federal Communications Commission to regulate the Internet under what is called “Title II of the Communications Act of 1934.” The call for Title II was immediately misunderstood and widely criticized. “Why should we tie the Internet to something set up 80 years ago?” the skeptics ask. It turns out there are several good reasons, and they get to the heart of how the Internet helps our economy.

The most important issue is simply the cost and speed of the Internet connections that Internet Service Providers offer to their customers. This has nothing to do with so-called “paid prioritization,” the question of fast lanes versus slow lanes. For most Americans, basic cost and speed is much more important. And it is easier to understand what is at stake.

The Internet has moved from a “nice to have” to a “need to have” in our society. Without a broadband connection, people have a hard time applying for jobs or getting vital medical and financial information. Top-quality college-level courses are available for free if you have a fast Internet connection – but not if you don’t. Internet access helps a person become economically self-sufficient, and it can help parents give their kids the knowledge and skills they need to survive.

Eighty years ago, the plain, old-fashioned voice telephone was the emerging “need to have” in our society. Without a phone at home, you were at a distinct disadvantage. Our economy had grown dependent on the telephone.

But there was a problem back then, and we face a similar problem now: It was much, much cheaper for a phone company (then) or an Internet Service Provider (now) to provide service in dense urban areas as compared to rural areas. For each rural subscriber, the phone company had to erect dozens of phone poles and string miles of wire. To make matters worse, there was almost never any competition to drive down prices in farm country. Many rural residents could simply not afford a phone.

But what was good for the phone companies was bad for the country as a whole. We needed to get nearly everyone wired or our economy would lag. So regulators came up with an idea called “ Universal Service”: Phone companies were required to charge all subscribers the same amount for a low, basic level of phone service. This meant that phone companies would slightly overcharge the many city dwellers while subsidizing those in rural areas. It distorted the market a little, but it meant that everyone could afford basic phone service. This worked splendidly and soon nearly everyone had a phone.

Without regulation or the threat of it, and without antitrust action, broadband access will get much worse in rural America. In theory, competition can solve the problem. But today there is very little competition among Internet Service Providers in the U.S. Each provider covers a patchwork of territory and most places have no more than two providers. Many parts of the U.S. have only one.

You don’t need a degree in economics to predict that without competition, prices go up and speeds fall. And indeed, almost everywhere in the U.S., broadband is slower and costs more than in most developed countries. A recent study by New America Foundation (which is neither predictably liberal nor conservative) showed that America is falling behind. It found that a few cities like Chattanooga, Tennessee, have fast service at low prices, but in most of the U.S., it’s hard to do much better than $130 per month for a 150 Mbps home broadband connection. Meanwhile, in Paris, France (hardly a cheap place to live), “speeds of 100, 200 and 300 Mbps are available … for around $30/month.”

When the Internet was new, and no Internet providers had much market power, regulation was not needed. In fact, deregulation was needed (for example, the Carterfone decision) to keep AT&T from strangling innovation. But those days are behind us, and the Internet Service Provider sector of the Internet is dominated by large corporations with considerable market power.

Comcast, Time Warner, AT&T and other providers are just doing what any smart corporation would do given a lack of competition, regulation or pressure of some other kind. The best solution would be to ensure robust competition among providers. That could be done under another regulatory concept called “comparably efficient interconnection,” which worked well until it was demolished in the late 1990s.

Ironically, the fight against Internet regulation gets much of its support from Republicans in sparsely-populated rural states. But the residents of these states are the ones who will suffer most from high prices and poor speeds, once the providers are free of the threat of regulation. So much for self-interest.

It’s sad how easily we throw away the measures that protect us from economic disasters. Whenever something in our economy is working well, some people say that its success “proves” that regulations are no longer needed. But often it is the regulations themselves that ensure prosperity and growth, and once those regulations are repealed, disaster follows. For example, in the banking industry, the Glass-Steagall Act prevented the failure of systemically important banks for 66 years until its repeal in 1999. The framework introduced in the Telecommunications Act of 1934 gave us years of efficiency gains, price reduction and universal access to a vital technology.

So why turn to the Telecommunications Act of 1934 to regulate the Internet of tomorrow? Because large portions of it still apply. The economics of spanning sparsely populated areas with telecommunications networks haven’t changed much in the past 80 years, and neither have the challenges of too little competition.

David Brodwin is a Co-founder and board member of American Sustainable Business Council. This article appeared in U.S. News & World Report November 21, 2014.

Building Better Capitalism

Six years past the Great Recession, job growth has rebounded. Corporate profits and top-tier incomes have soared. Unfortunately, most Americans have yet to see their incomes budge. This divergence has prompted searching questions about capitalism itself, and whether our grasp of economics has kept up with a changing world.

Entering the debate now is McKinsey & Company, the elite consultancy that advises many of the world’s leading corporations. In a recent article in the McKinsey Quarterly, Eric Beinhocker, a McKinsey alum now leading the Institute for New Economic Thinking, and Nick Hanauer, an entrepreneur and venture capitalist, raise several important points. They question long-accepted doctrine and propose a new way to think about capitalism:

Rational, self-correcting markets vs. wild horses: Conventional economic theory holds that customers make rational decisions based on a sound understanding of their own self-interest, and that markets can be relied on to set the proper price for everything. Beinhocker and Hanauer argue that the mortgage crisis shows the fallacy of both of these notions. Customers — even sophisticated bankers — were nothing close to rational in their embrace of mortgage derivatives. And the market participants behaved like a spooked “herd of wild horses” that could not calm itself without massive government intervention.

Problem solving versus resource allocation: Conventional wisdom has it that the most valuable feature of capitalism is its ability to allocate resources – to make sure that enough goods and services are produced to meet demand, and to make sure that those who are intelligent and hard-working are rewarded for their efforts. Beinhocker and Hanauer claim that resource allocation is actually of secondary importance; the real benefit of capitalism is its ability to generate innovations. Some of these innovations save lives (like antibiotics), while others simply make life more enjoyable.

Effectiveness, not efficiency: The authors argue that capitalism is more about effectiveness than efficiency. Effectiveness means the ability of an economy to generate important innovations. Capitalism, particularly in the presence of a strong venture capital system, excels at promoting innovation. But innovation is a messy and inefficient process. Among venture–backed startups, fewer than three in 10 succeed.

Measures of efficiency are misleading. Efficiency tells us how cheaply things can be made. But things can be made cheaper in ways that don’t help the economy, and they often are. A company can drive down wages by offshoring; that shows up on national accounts as a gain in efficiency. But when that happens on a large scale, across the entire economy, the purchasing power of consumers falls as quickly as prices fall, so the economy as a whole is no better off.

Efficiency, as conventionally measured, also misleads us because it fails to account for hidden costs. For example, importing oil from the Middle East may seem efficient because oil costs less than other comparable fuels. But when we account for the cost of fighting a perpetual war there, it’s not efficient at all.

Prosperity means better stuff, not just more stuff: In measuring the performance of an economy it’s important to differentiate between making new and better stuff versus simply producing more stuff. For example, in the U.S., most of us are awash in calories. We don’t need the agriculture system to produce more calories, yet our agriculture subsidies encourage just that. The obesity that results hurts people as individuals and burdens the economy with soaring health care costs.

Dethroning GDP: For all these reasons, gross domestic prodyct misleads us about the health of the economy. Growth in GDP supposedly means our economy is improving, and GDP has more than tripled over the past three decades. But GDP includes many kinds of economic activity we’d rather not see. For example, when both parents must work long hours to make ends meet, they must send their kids to day care. The added revenue for day care counts as a gain in GDP. But does that make us better off as a society?

Managed markets, not free markets: Government and business are highly intertwined, and rethinking capitalism inevitably means rethinking the role of government. The authors say that “perfect markets” that “work best when managed least,” “don’t seem to exist in the real world.” A healthy democratic process is needed for “navigating the trade-offs and weaknesses inherent in capitalism,” from the instabilities of financial markets to the overproduction of calories, and more. Unlike the U.S. Chamber of Commerce and many other business lobbies that vigorously oppose regulation, the authors say that good regulations are essential for working markets, and they note that unregulated economies are “universally poor.” (Some business groups, like American Sustainable Business Council, have long taken a pro-regulatory position.)

Beinhocker and Hanauer’s work is an important and welcome contribution to an urgent debate. Cronyism, climate change and the concentration of extreme wealth in the hands of the few all threaten the vitality of the U.S. economic system. We must find ways to make capitalism work better, so we can continue to benefit from what it does well, while findings ways to solve the problems it creates.

David Brodwin is a Co-founder and board member of American Sustainable Business Council. This article appeared in U.S. News & World Report November 17, 2014.