Wednesday, October 14, 2009

Why Government Regulation for Internet Service Providers Is Bad News

Our government has settled on a new formula for regulating industry, and they are applying it to one industry after another. While they haven’t yet made it to the restaurant business, at this pace we may not have to wait too many years for the following to happen: Every restaurant is mandated to only offer food in the form of an all-you-can-eat buffet. The government decides on what needs to be served on this buffet, at a minimum, in order to be compliant. No restaurant is allowed to deny a customer service, and all customers must be charged the same price. After all, eating is no longer one half of an exchange of private property, but a “right” entitling a consumer to his neighbor’s property.

What would happen to the restaurant industry if it were regulated this way? 300 lb people would pay the same as 100 lb dieting models, all while abusing the buffet’s contents. The restaurant owner, unable to discriminate or restrict, would have to raise the uniform price to reflect the heaviest consumer, at which point the price becomes unacceptable to the lighter consumer. Unable to reduce cost because of the requirement to provide a minimum level of content, the restaurant would under-invest in other areas such as kitchen and furniture; yet profitability would suffer despite the higher price. Eventually the government steps in to limit the price restaurant charges for the buffet. Cost then exceed revenue. Bankruptcy follows.

Crazy, you may say. Of course it is! But now apply the mad scenario of the government-regulated lunch buffet to two other industries: Internet Service Providers (ISPs) such as AT&T (T) and Verizon (VZ), and the health care industries, including insurance companies. Let’s take these two industries in turn.

Internet Service Providers (ISP): The drumbeat is on from the FCC and Congress to force companies such as AT&T and Verizon to “open” their pipes to positively anything that any user wants to do. Think the streets of San Francisco, where lawlessness and filth have become rampant. According last week’s AT&T management presentation at the CTIA in San Diego, 3% of its wireless users consume 40% of the bandwidth. Unless AT&T can charge these people more – the more you eat, the more you pay – its economics will collapse under its own weight. Casual users don’t want to pay for the investments necessary to keep a high level of service for those who use the most resources.

Charging people for usage can be a good thing, but for Internet bandwidth it can make for a tough consumer proposition. Most people have no clue how much they just consumed by clicking on a web page. I sure don’t. As a half-measure and compromise, AT&T and Verizon want to “traffic-shape” the consumption by having computers monitor user behavior and throttle down extreme usage scenarios. By doing so, they believe they can maintain flat-rate pricing for at least a bit longer, instead of having to charge per bit. This attempt at establishing order between those who take advantage of the all-you-can-eat buffet, and those who just eat “normal” or even little, is at a bare minimum a property right of the service provider.

Under many so-called “Net Neutrality” proposals, the government would deem such a “traffic-shaped” consumer offer illegal. You see where this is going: The government (FCC and Congress) passes a law proclaiming Internet-In-Your-Pocket a “right”, mandating a uniform level service that must be offered to all, and denied to none. Telcos and ISPs are then forced to invest to meet the demands of high-intensity users paying the same low flat rate as my grandma. Unable to raise prices, profitability falls, turns into losses, and bankruptcy follows. In the end, the government takes over AT&T, Verizon and all the others, offering a taxpayer-subsidized one-size-fits-all Internet that brings us to the level of Cuba’s consumer welfare. That’s the government-regulated lunch buffet applied to Internet service.

Then let’s apply the same principle to health care and related insurance. States and soon the Federal government impose mandates as to what a health insurance policy must cover: Thousands of details for all sorts of procedures, dramatically driving up cost. Because these are state rules, they almost automatically outlaw inter-state competition, in direct defiance of the commerce clause of the Constitution. While all normal insurance companies – car insurance comes to mind – price customers individually based on perceived risk and past behavior, the government forces health care insurance to charge only one price for customers, whether they appear super-healthy or a likely multi-million dollar liability. Put aside the emotion for a moment: As a businessman, would you ever knowingly agree to do business with a customer who you think is likely to lose you money? Of course not. That’s the fastest road to bankruptcy. Yet that’s the essence of the health care “reform” now making itself through Congress.

In the old days of The Cold War, we used to define Communism and Socialism as ownership of the means of production – banks, car companies, etc. The current plans to mandate a one-price lunch buffet for Internet access and health care insurance don’t directly confiscate the shares of the companies providing those services. Rather, the government seeks to use regulation to smother rational economic behavior, forcing the inevitable bankruptcies, surely swiftly followed by a massive bailout of all of those companies. Think Citibank (C), Chrysler and General Motors.

If there is a serious objective to maintain a free enterprise system, all efforts to regulate services and products must be rejected. All price controls must be rejected. And finally, the core principle at the heart of this country’s 220 year legacy – private property, which implies freedom of contract – must be vigorously defended. With the government attacking the Internet service provider market and the health care industry market with mandates and price controls, the opposite is now happening. If the US government now gets its way, profitability in these companies will be dealt a body blow, most certainly leading to lower stock prices on an inflation-adjusted basis.