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Net Neutrality - Why It Is Destined to Collapse

21/08/2014 16:00 BST | Updated 20/10/2014 10:59 BST

Earlier this year, America's FCC announced the biggest U-turn in the history of internet regulation by withdrawing its support for net neutrality and proposing new rules that allowed internet service providers to charge internet companies for "fast lane internet access", setting the path for creating a two tier internet.

Net neutrality rules are associated with the founding principles of internet regulation. They stipulate that telecom operators should not favour internet traffic from specific content providers.

The FCC surprised most of the world when it dramatically changed its stance in May 2014. Its proposals - currently out for public consultation - included a "minimum level of access" rule and a "fast lane access" rule. The first rule ensures the internet remains free and open, allowing every voice to be heard. The second ensures ISPs will be incentivised to invest in high speed broadband infrastructure. The FCC faces fierce resistance to its proposals. A final policy decision is expected some time after the public consultation period ends on 15 September 2014.

With so much at stake it is worth recapping the series of events that led to the FCC being boxed into its current predicament.

In January 2014, a US Supreme Court ruled that the FCC had no authority to instruct internet service providers how to manage internet traffic. Until then everyone assumed the FCC regulated ISPs. In its ruling the Supreme Court argued that ISPs were not telecom operators (which the FCC is authorised to regulate) but internet services (which are free from government regulation). The following month, Netflix, a video streaming service, agreed a "fast lane access" deal with Comcast, a large ISP, to ensure its online videos were streamed smoothly.

These two events broke the status quo and threatened the future of net neutrality. As a result, the FCC was forced to clarify whether it would, in future, find a way to enforce net neutrality rules on ISPs or not.

Regulatory policy, by definition, distorts markets, often for a "higher purpose". But as with all market distortions, there can be unintended side effects.

When net neutrality rules were originally introduced to support a fledgling American internet sector back in the early 1990s, the market distortion was that US telecom operators were made to subsidise the US internet sector; the higher purpose was a high growth, innovative internet sector for the US and the promotion of freedom and America's democratic values around the world.

The policy worked.

Today, the internet is free, open and innovative. It is also highly profitable. Indeed, internet companies like Apple, Google and Facebook - who benefited most from net neutrality - are now worth more than most telecom operators.

But there was an unintended side effect. US and European telecom operators cut back on investment in high speed broadband networks because, under existing net neutrality rules, it simply did not make commercial sense. There were too many free-riders. As a result, the US and Europe have been falling rapidly down the world league of broadband speeds.

As a regulatory policy net neutrality is now unsustainable. It is incompatible with the notion of a high growth knowledge economy because it does not provide adequate capital returns to those charged with investing in the high-speed broadband infrastructure that makes it all possible.

Internet traffic is growing so fast that the quality of service for many internet users is suffering as networks get clogged up. The problem is particularly acute on mobile networks. When a resource is scarce, the only way to bring supply and demand into equilibrium is to price that resource accordingly. The FCC has come to the conclusion that abandoning net neutrality is the only way it can restore market equilibrium.

Supporters of net neutrality argue that an "open internet" is essential in order to encourage innovation and free speech and promote democracy.

Opponents of net neutrality argue that net neutrality is now holding back the large-scale investments in broadband infrastructure that many western economies desperately need.

Both arguments have their merits.

Regulators know that the internet needs to stay free and open. But they also know that there needs to be strong commercial incentives in place for internet service providers to invest in broadband infrastructure. Otherwise the west will continue to fall behind emerging Asian economies in the race to dominate the knowledge economy.

Striking the balance will be no easy task.