05/27/2010 02:43 pm ET | Updated May 25, 2011

FCC's Bold, Risky Move to Regulate the Internet

The Federal Communications Commission moved aggressively last week to open a new round in the debate about the extent of its regulatory sway over the Internet. Until this month, the Commission had never claimed a sweeping and specific statutory right to regulate the Internet, because Congress has never provided it. Yet, when a federal court recently rejected FCC arguments that it has limited, "ancillary" authority to govern certain practices of the companies that operate the web - the FCC position under both President Clinton and President Bush -- the current Commission doubled down.

Now, the FCC claims specific statutory power to regulate the transmission part of broadband services under its long-time, "Title II" authority to regulate telephone service. Lawyers and judges will settle the legal issues; and the outcome will not only help shape the future of the Internet, but also could influence the path of the rest of the economy.

The economic issue here is one encountered regularly in regulation of many other industries, from airlines and pharmaceuticals to transportation and energy. Regulation is clearly necessary in many aspects of economic life. But regulations always work in the favor of certain companies compared to others, and usually influence an industry's investment patterns and general path of development. The result is that much of regulation tends to insulate favored companies from normal competitive pressures, which in turn tends to dampen critical innovation. From airlines or electricity generation to long-distance service before deregulation, there is extensive economic evidence and reasoning behind the claim that regulation stifles innovation.

Since regulation is sometimes vital for the economy's stability and growth, the question becomes how to strike the proper regulatory balance between encouraging investment and innovation while protecting consumers from bad actors.

The short answer is to look to the results. Largely free from regulation, Wall Street created scores of new and "innovative" financial instruments and new ways to account for them - and the combination of those innovations and the absence of most regulation ultimately blew up many of the largest financial firms and nearly took down the American and global economies. The new regulatory regime which Congress is currently fashioning for big finance will carry real, economic costs. It will lessen some of the incentives to develop new products and new ways of doing finance, because the regulation will point Wall Street in certain directions, independent of markets, and constrain the sector's phenomenal profits.

However, those costs are reasonable and necessary, because it's now clear that Wall Street's unregulated ways of earning those profits risk a second Great Depression for the rest of us. And the taxpayers who picked up the tab when financial firms failed in the recent meltdown have the right to set new rules that will reduce the likelihood that they've have to pay again.

None of these matters applies to the Internet. First, the companies that provide Internet service (and content) deliver increasing value to most Americans. For example, Internet service providers have made extraordinary progress towards universal access to broadband, the President's top priority. In the last decade, the proportion of American households with broadband went from virtually zero to two-thirds of the country, the fastest rate of uptake of any new technology on record. This progress came under limited regulation reflecting a bipartisan agreement that the government should not try to micromanage something as technically complex and interdependent as the network of networks that comprise the Internet. This progress also was driven by innovation, especially the technological advances and new network management approaches that have gradually brought down the price of broadband service.

And economic simulations show that this trajectory should move the United States towards universal broadband within this decade -- unless new FCC regulations effectively bar broadband providers from adopting business models that would help finance the continued build-out of broadband infrastructure. For example, rules that would limit an Internet Service Provider's (ISP) ability to charge big content providers for the high-volume, high-capacity bandwidth consumed by their video applications would force ISPs to either raise monthly fees for all consumers or slow the expansion of the network because of revenue shortfalls. The first option would slow down broadband adoption, and so extend the current digital divides by income and race; while the second would slow down Internet transmissions for everyone.

In truth, the potential costs of a regulatory regime that would stifle stifling innovation on the Internet are potentially enormous, because the Internet has so successfully enabled valuable innovations in sectors across the economy. The steadily-growing power of broadband service and the applications developed for it have driven profoundly useful innovations, for example, in how hospitals and police departments operate, how consumers and businesses purchase many goods and the services, and in the nature and range of the goods and services that hospitals and police departments provide and that consumers and businesses purchase. Constraining Internet innovation could well wind up limiting advances across many parts of the economy.

The Internet's operations raise legitimate issues for regulators, who should work to ensure, for example, that consumers' rights are fully respected in the online environment. Yet, given the enormous stakes for all of us in the vast range of innovations being driven by broadband service and its applications, sweeping new rules for the Internet should not come by regulatory fiat, but only after careful and extended debate by both the Administration and the Congress.