THE DIGITAL PAST AS PROLOGUE: How a Combination of Active Public Policy and Private Investment Produced the Crowning Achievement (to Date) of Progressive (American) Capitalism Mark Cooper, Director of Research, Consumer Federation of America, Senior Fellow, Silicon Flatirons, University of Colorado Regulating the evolving broadband ecosystem, AEI/University of Nebraska Forum Federal Communications Commission, September 10, 2014 I want to thank the AEI and the University of Nebraska for giving me the opportunity to speak on the important topic of regulating the evolving Internet broadband system, especially Jeff Eisenach, who I first met a dozen years ago at a big Cato Hill event, which was entitled, ironically, Too Much Deregulation or Not Enough. At that event, he may recall, I declared that I am a devout capitalist, a member of a very specific sect of capitalist preachers— progressive, democratic capitalists. “I believe that US capitalism dominated the 20th century because we found the right balance between private incentives and public responsibilities… a way to impose social obligations without undermining the profit motive. I recognize that regulation can go too far, creating too heavy a social obligation, which will slow the capitalist economic engine down. However, I also insist that we can go too far in deregulating, encouraging antisocial behavior, and allowing the capitalist engine to spin wildly out of control. Balance is the key. As the title of my paper indicates I am still of that persuasion. In fact, I not only believe that the digital economy is the crowning achievement of capitalism, but that we must adhere to the principles of progressive capitalism if we are to secure its future success. I present my qualitative analysis first, then provide supporting data in a series of slides. In the great debate over regulation of the communications network on which the Internet rides the right and the left are each exactly half right (and, consequently, half wrong): The right is correct to trumpet the important role of entrepreneurship, innovation and private investment in driving the digital revolution, but is dead wrong in denying the critically important role that active public policy played in creating the environment for success and the vital need for active policy to preserve and protect that environment. The left is correct to trumpet the important role of active policy; but is dead wrong to deny the critically important role that the private sector played in creating the digital revolution and must play in continuing to innovate and expand the digital space. I promise to be an equal opportunity critic in my remarks, and judging from the most recent round of letters to policy makers, that will be easy. Both sides want light-touch regulation, but neither properly depicts the regulation that has worked so well. The touch was heavier than the right admits, and lighter than the left assumes. To design policies to promote the continuing progress of digital communications we must understand the ways in which the 1 combination of public policy and private actions created the digital revolution and recognize the threats that “undisciplined” private or public power pose to the engine of growth. Progressive capitalism reduces market imperfections and barriers to make markets work better, improving productivity and expanding output. The digital revolution reminds us that reducing market imperfections is not only about preventing the negative consequences of imperfect market structures – like the abuse of market power, perverse incentives, or the exploitation of asymmetric information. It is also about enhancing positive attributes of economic systems, like provision of public goods, building dynamic innovation systems, enhancing network effects, and mobilizing untapped resources by lowering transaction costs. Slide 2: A pervasive and intense improvement in market functioning resulting from the combination of public and private action created the internet innovation system that is driven by a Virtuous Cycle of which has become the engine of the digital economy. Entrepreneurial experimentation at the edge of the network creates demand for new services that elicits investment in network capacity and functionality, which stimulates further edge experimentation, creating new demand and repeating the virtuous cycle. Today we labor in what I call the Quarterlife Crisis of the digital revolution to create a Socio-Institutional Framework to ensure its dynamic functioning, growth and expansion. Public policy tilled the ground in which the seeds of the digital revolution could be planted and grow by providing key building blocks that would not have been provided by dominant incumbent communications sector companies. These include Large, sustained support for basic research, development and initial deployment of key technologies, particularly in the 1960s A commitment to develop decentralized communications networks for strategic defense, again in the 1960s A long standing New Deal tradition of pricing to promote use (that is, bill-and-keep for interconnecting communications companies and flat rate pricing for end users). The FCC fertilized the ground by adding mandatory opening of access to bottle neck communications facilities again in the 1960s, which ensured Neutrality of the communications networks for data transmission and openness to network devices, No need to engage in costly bilateral negotiation over the cost and quality of access Freedom to experiment, and Interoperability of data flow 2 The private sector responded to the opportunity with the energy that only capitalism can provide, Massive entry and entrepreneurial experimentation that created a new mode of production relying on Platforms with divided and diverse technical platform leadership Specialization of supply firms New relationships to capital markets, and User driven innovation to an unprecedented degree Voluntary, multi-stakeholder, self-regulation created and preserved open protocols that facilitated collaborative production and ensured the digital space would continue to be friendly to entry, innovation and investment. While these voluntary efforts were vital to the success of the Internet innovation system, it is a mistake to believe that they would have succeeded without the strong action of the FCC to create and preserve the space of freedom for entrepreneurial experimentation. It is also important to recognize that these efforts were led by new entrants and innovators, not dominant incumbent network owners and even more important to remember that at every step along the way, the dominant network owners expressed hostility to open decentralized communications networks, allowing the freedom to attach “foreign equipment” to the network, and the obligation to afford data nondiscriminatory access to the telecommunications network. System level characteristics emerged as positive externalities to reinforce the “virtuous cycle” including an expanded division of labor, network effects, learning externalities and knowledge flows. Outside of the economy, there has been an immense increase in “weak ties” interaction and the participatory governance of everything. With a half-century of success, it is easy to forget the essential role of the balance between public and private action. However, the ecology remains vulnerable to pollution that can sap its strength and undermine its ability to survive. The threat of pollution emanates from both the public and private sectors and is underestimated by both right and the left: On the right we find baseless claims that the dominant communications providers no longer have the incentive and ability to undermine the open flow of communication, On the left we find naïve beliefs that command and control regulation will not strangle innovation and that public sector entities can provide the necessary innovation. The right ignores the clear evidence that network owner have an interest in setting the pace and controlling the direction of innovation and taxing successful applications to defend and increase their rents. If they are allowed to do so, they will ruin the economic engine, dampen the “virtuous cycle” by undermining the willingness and ability of the edge to experiment. They can 3 impose counterproductive uncertainty about access to the network and its devices, increase costs substantially by forcing edge entrepreneurs to engage in bilateral negotiation, undermine interoperability, and chill innovation through the threat of “hold up” of successful edge activities. Incumbent network companies have a conservative, myopic bias, making them less innovative and dynamic with strong preferences for: preserving the old structure, pursuit of incremental, process innovation rather than radical, product innovation, and a proprietary culture that prefers restrictions on the flow of knowledge. Competition is much weaker in the network segment than at the edge, which means incumbent network companies face less pressure to innovate, have the ability to influence industrial structure to favor their interests at the expense of the public interest, can use vertical leverage (where they are integrated) to gain competitive advantage over independent edge entrepreneurs, and can extract rents, where they possess market power or where switching costs are high. The challenge for policy is to prevent them from doing so and develop and ensure funding of investment in infrastructure without undermining innovation.