Progress Snapshot
Release 3.2 February 2007

by Scott Wallsten*

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A recent paper by Tim Wu discusses "Wireless Net Neutrality." He suggests that several features of the U.S. wireless industry may harm consumers. Essentially, he wants wireless carriers to open their networks in particular ways. He advocates creating standards that will make it easier for developers to write applications and for hardware firms to create devices that will operate on a network, and argues that wireless providers follow some "net neutrality" standard for use of the spectrum itself.

It is an interesting paper, but is flawed in several fundamental respects.

First, Wu writes as if this were a new issue. Just like the broader debate over network neutrality, in reality this is another version of an extensively debated topic: when should a network operator be forced to allow users particular types of access to its network? Wu ignores the history of this type of regulation.

Most advocates of network access regulations base their argument on a plausible assumption that some firm has enough market power to profitably act anticompetitively. The wireless industry displays no such evidence of a market failure. Indeed, the evidence suggests that the wireless market is competitive and has brought tremendous benefits to consumers. The figure below for example, suggests that prices have, on average, decreased substantially while mobile use has soared. Wu correctly notes that entering the market takes a lot of capital, but that does not by itself indicate a market failure. The presence of four major national carriers and several regional players (some of which have now bought enough spectrum to eventually provide nationwide service) suggests that investors are able to mobilize resources to enter the market.

Thus, even if one believed that regulating network access could improve competition when a monopolist dominates an industry, the lack of a market failure in the wireless industry suggests that such regulation would be completely unwarranted.

Moreover, network access regulations do not have a strong track record of success even when one can credibly argue that a market failure exists. We saw such regulations in the U.S. under the UNE-P regime, when the telcos were forced to sell access to their networks to competitors at regulated rates. Proponents had hoped that unbundling would have a "stepping stone" effect by allowing competitors to enter the market and then, once they had a customer base, would begin to invest in facilities. Unfortunately, it did not turn out that way. Few of the CLECs, as they were called, invested in facilities, while the sharing regulations reduced investment incentives by the telcos.

Given the unimpressive history of network access regulations, one should take care in imposing them under any circumstances. Imposing them in a competitive industry like wireless makes little sense. Regulating a competitive market is likely to distort investment incentives and ultimately harm consumers.

Nevertheless, it is worth evaluating a few of Wu's specific points.

Wu is concerned about the carriers' controls over how their networks can be accessed and used. He compares wireless providers’ restrictions to the bad old days when AT&T the monopolist refused to allow any "foreign devices" to connect to its network because, it claimed, such devices might damage its network. This claim reached its peak of absurdity when AT&T tried to ban the hush-a-phone - a plastic device that snapped onto the telephone's mouthpiece to block out background noise.

AT&T's network attachment rules largely protected its monopoly rather than its network. However, comparing the pure monopoly of Ma Bell to today's competitive wireless industry makes for a flawed analogy.

As Wu seems to understand, the current system may reflect, in part, a lack of standards. Indeed, one of his recommendations is for the industry to "work together to create clear and unified standards to which developers can work."

The challenge of creating standards is far more complicated than Wu implies. Standards can be important to an industry, but it is not always obvious how to establish them. One approach is to allow all the firms in an industry to work together to create standards, as Wu suggests. This approach can have large benefits, but must be balanced against the possibility of undercutting competition and promoting collusion. Some cooperation among firms is important, which is why Congress passed the National Cooperative Research and Production Act in 1993 to allow firms to collaborate on certain research ventures with some protection from antitrust prosecution. Finding the right balance between competition and collaboration is an ongoing policy challenge.

Moreover, it's not at all clear that Wu himself would be satisfied with standards developed this way. For example, he decries the industry-created WAP standard for viewing web pages. The point here is not to praise or criticize WAP, but to point out that standards are difficult to create, and that Wu was not happy with one standard created under the type of system he seems to now advocate.

Creating standards, especially in high-tech industries that involves a large number of firms, is complicated and there is no single right way. Wu demands that the industry overcome this problem, but it's an issue that has been debated for decades.

Wu is also concerned about the common industry practice of wireless carriers deciding which phones can operate on their networks. Wu asks, "Why can't you just buy a cell phone and use it on any network, like a normal phone?" Part of the answer is that "you can." As he notes, GSM networks (T-Mobile and AT&T in the U.S.) will accept any GSM-compatible phone that is built to operate on the correct frequency. Amazon has a page explaining how to use unlocked GSM phones and seems to offer 163 different phones for this purpose. It would be interesting to know whether the ability to purchase unlocked phones is one of the reasons some customers are attracted to T-Mobile's and AT&T's networks. Another part of the answer is that carriers subsidize handsets to induce people to sign contracts. Would some people prefer to buy unsubsidized handsets and not sign contracts? How much would consumers be willing to pay for handsets? Do subsidies increase demand for handsets? If so, how does this increased demand affect innovation? Unfortunately, Wu seems to already have decided his preferred answer to these questions.

Some of Wu's claims may have merit. For example, he is concerned that some advertising may mislead consumers into thinking that they are purchasing unlimited access to a carrier’s 3G network when, in fact, their total monthly allowed use is typically capped.

Overall, though, the wireless industry is robustly competitive and exhibits scant evidence of a market failure. Consumers consistently benefit from increasingly lower prices and more features. This competition shows no signs of letting up. To ensure that competition and innovation continues in this market, the FCC should continue to move spectrum into the market quickly and make its use flexible and allow it to be traded.

The recent AWS spectrum auction and the upcoming 700 Mhz auction are big steps in the right direction. More spectrum will ensure that existing wireless carriers can improve their services and that new firms will be able to enter the market.
Any proposed regulation must always be considered carefully to ensure that it carefully targets a specific market failure and that the benefits of the regulation are expected to exceed its costs. The wireless industry exhibits no evidence of a market failure, and regulations - especially sweeping ones of the type Wu would like us to consider - are likely to impose significant costs on society and ultimately harm consumers.

* Scott Wallsten is a senior fellow and director of communications policy studies for The Progress & Freedom Foundation. The views expressed here are their own, and are not necessarily the views of the PFF board, fellows or staff.