There is some strong precedent for this criticism since it is not a new economic phenomenon.  Emile Dupuit observed of the French rail system in 1849:

It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that some company or other has open carriages with wooden benches … What the company is trying to do is prevent the passengers who can pay the second-class fare from traveling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich … And it is again for the same reason that the companies, having proved almost cruel to the third-class passengers and mean to the second-class ones, become lavish in dealing with first-class customers. Having refused the poor what is necessary, they give the rich what is superfluous.

As I wrote in a previous Cool Stuff, I am not inherently opposed to two tiered pricing.

Sometimes even an economist will spend £5 to ride in an open carriage, if it makes his kid happy.

Even in common carriage networks there has been tiering and prioritization, such as business and economy classes in rail and air transport, for example.  In traditional a telephone networks, there was tiering. Although every one got VGS (voice grade service), under the Bell System there was still business and residential classes of service.  The network was capable of certain forms of call prioritization in emergencies, calls to 911, calling out prioritization over calling in, and GETS (Government Emergency Telecommunications Service).  There was also prioritization based on first-in-time.  The telephone network was designed to handle only fraction of capacity, and on occasion, you might get an “all circuits are busy” message when your call blocked.

More troubling than a two-tiered Internet is the in the way which the deal could misalign economic incentives.  The Google-Verizon deal could change to the way networks compensate one another for carrying traffic to their respective customers, if the content or application provider is paying for better service on the enduser’s network.  There are basically three ways networks can compensate one another: calling-party-pays; receiving-party-pays; and bill-and-keep.  Money changes hands as their names suggest.  Bill-and-keep is the way most Internet traffic is exchanged (peering).  It works well when the networks are roughly equivalent in size, traffic flows, and cost-causation.  Receiving party pays is how most cell phone networks exchange traffic in the US.  It provides pretty good economic incentives.  The problem with the Google-Verizon deal is that it could be, in effect, a calling-party-pays arrangement.  Without regulation, these arrangements provide the opportunity for carriers to shift costs to rival networks and engage in other system-gaming.  When dealing with a “termination monopoly” such as an Internet connection, traffic should be exchanged under receiving party-pays or bill-and-keep arrangements.  The termination monopoly exists anytime there is only one network which can terminate traffic to a network end point.  It is surprisingly durable.  Even there is a healthy number of competitors in access networks (fixed or wireless), once a subscriber chooses a particular network, he forecloses all other ways for other network participants to send him traffic.  It is in the termination network’s interest to keep prices low for its subscribers and charge high costs to other networks’ subscribers. In the current case, this fact is Okay for Google because it has lots of cash.  However, its competitors and start-ups might not be able to pay for such termination.  In this way, the Google-Verizon deal could in the long run serve to limit others from the market place.

In the end, either competition or regulation has to constrain this behavior.

Insight: Google Verizon proposal is not so much a threat to network neutrality (lower case) as it is to network economics.  Part of this is the public face of a private bargaining game. Players in the value chain are using the political and regulatory process as they struggle to gain a larger share of that chain.  It is not evil, merely self-interested.  That is fine.  At some level, Google and Verizon should be lauded for working towards a compromise and to move things forward.  But, they should not get to make public policy.  That is the exclusive domain of Congress and the FCC.  The FCC should take those views into account then offer its own independent decision to impose regulation or not.  Professors Susan Crawford and Lawrence Lessig (both of whom I admire very much) get this exactly right in their Op-Ed last week.  If Google and Verizon want to offer an internet without a roof, the FCC should make sure that another company is able to offer a competing one with a roof.

Is a two-tiered Internet a bad thing?

Honestly, I don’t know.  On one hand, it offends my basic sense of fairness.  On the other, my economics training tells me the price discrimination is a good thing (in competitive markets).  I have been thinking, writing, and speaking (in that order) on Network Neutrality for about four or five years.  My work has been published in English, Japanese, and Italian is forthcoming.  The one thing I have consistently said is that Internet subscribers, when well-informed, with real competitive options, and faced with low switching costs, will punish ISP who are not giving them what they want.  Competition is deputizes consumers to vote with their wallets.  If a two-tiered Internet is a good thing, then a competitive market will support it.

Almost all commenters agree that the cause of Network Neutrality issue is the reduction of competition in Internet access in the US.  This follows from a series of FCC decisions which basically eviscerated its local competition rules (mostly in the form of unbundling) in favor of “market solutions”.  The major proceeding which changed these rules was the Triennial Review.  In the proceeding, incumbents told the FCC that unbundled network elements (UNEs) were bad because they discouraged investment.  The competitors argued that UNEs were good because they were necessary for network competition.  I find both of those statements true and not mutually exclusive.  It is possible for a well-intentioned, well-informed regulator could split that baby down the middle, and still throw out the bath water.  In other words, regulators can create an effective unbundling regime which mitigates the disincentives to invest while still enabling competitive entry.  Indeed, nearly every other industrialized country has some form of unbundling for local competition.

What makes this difficult in the current political climate is that UNEs and TELRIC are incredibly dull.  It is much easier to get people excited about a topic like Network Neutrality than long-run incremental costs.  So, you cannot generate the political will for a return to unbundling.

Insight: There is now a unique opportunity to move beyond the Network Neutrality debate.  However, regulators should regulate, not negotiate.  The FCC should take this opportunity to revisit its unbundling rules to craft rules which can enable competition in Internet access networks while mitigating disincentives to invest.  Time to get excited about subloops!!

Recently in the United States, a number of so-called “deficit hawks” are advocating an extension of the Bush Tax Cuts while insisting that the deficit be brought down.  This makes no sense to me.

Let me present a model simple enough for me and my MBA colleagues to understand (I am not very good at math). Imagine the erstwhile Kingdom of Carteronia.  Gross Domestic Product (GDP) in Carteronia is CD$ 1,000. The government levies a 30% tax on all economic activity.  (The tax is the same for all income levels and for capital gains, so we don’t have to worry about wealth transfers, incentives or industrial policies).  Thus, revenues are CD$ 300 (1000 x 0.30) and the government has a balanced budget.  Recently, our rulers have decided to reduce the tax rate by three percentage points to 27%.  In order to maintain the same level of government expenditures and not run a deficit, GDP would have to grow in one year to CD$ 1,111.11 (300 ÷ 0.27).  This is an 11.1% growth rate and has to be stimulated by the tax cut and over and above the rate of inflation.

Think an 11.1% growth rate is possible?  Well, it would be nearly 4 times the annualized growth rate of US Real GDP, which was 2.96% between 1945 and 2009.  (It was only 1.70% per capita.) (See, http://www.measuringworth.com/growth/#)  Still think this is possible?  Consider the velocity of money.  Under the tax cut, citizens have a reduced tax liability of CD$ 30. Assume that they spend every last cent in the private sector.  Then every person has to spend every last cent of their reduced tax liability as well as any additional income it might generate several times – in fact about 35 more times in the year.

Insight: I don’t like paying taxes.  No one likes paying taxes.  If you like to pay taxes, you should have your head examined. Nonetheless, we all like the benefits that taxes can buy – the common defense and the general welfare, including: police, courts, highways, national defense, etc.  What the reduce-taxes and reduce-the-deficit augment hopes to do is: 1) dispense with a liability while retaining the attendant asset and 2) achieve an objective by deliberately behaving in a way guaranteed to produce these opposite result.  To an MBA’s mind, this is illogical.

The first commercial spread spectrum product, Telesystems' ARLAN, a radio LAN introduced in 1988. Source: FCC.

Today, the Wi-Fi Alliance and the Wireless Gigabit Alliance announced an enhancement to the current suite of 802.11 standards (Wi-Fi) which promises multi-gigabit wireless networking, in the 60 GHz frequency band.  The two associations expect that devices which have the new enhancement will be tri-band, also able to operate in the 2.4 and 5.8 GHz bands where Wi-Fi currently operates.

However, I am not sure if the Wi-Fi Alliance or the Wireless Gigabit Alliance realize the auspiciousness of the occasion of their announcement.  The announcement comes twenty-five years and one day after a much ignored FCC decision.  On May 9, 1985, FCC adopted rules which permitted the operation of spread spectrum systems in the ISM bands (902-928 MHz, 2.4-2.48 GHz and 5.725-5.85 GHz).  This rule change enabled the commercial rise of Wi-Fi, as well as so many other products and technologies take for granted today, such as Bluetooth, cordless phones, and baby monitors.

The FCC took this decision on its own initiative, rather than relying on requests for rule changes from the industries it regulates.  (In fact, many of the companies which initially opposed the rule change now earn millions of dollars of revenue from selling products that operate in these bands.)  One important person diving the FCC proceeding was national treasure Mike Marcus.  Marcus published a terrific account of the FCC proceeding in the journal info last year.  (I published in the same issue, and beat him out for best paper).  For his vision and insight in pushing the rule change through, Marcus was rewarded with nine years of exile to the outer Bureaus of the FCC.

Insight:  It never ceases to amaze me that a well-made decision can have exponential implications down the line.  Relying on the industry to tell the regulator can be helpful; however, this approach does not always serve the public interest.  In all instances, the regulator should exercise independent judgment.

A week ago, the Dutch telecommunications regulator Agentschap Telecom completed a spectrum auction for licenses in the 2.6 GHz band.  Five bidders spent just over €2.6 million to acquire 130 MHz of the 190 MHz in the band, but they did so in an unusual way.  Agentschap’s auction had two parts.  In the first part, bidders vied for a certain amount of spectrum.  In the second round, the bidders competed for specific 5 MHz blocks, with the option of single 5 MHz blocks of unpaired (TDD) spectrum or 2 x 5 MHz blocks of paired (FDD) spectrum.  This determined the pairing the band.  No FDD spectrum was acquired.

In this way, the auction determined whether the spectrum would be used for cellular type uses (FDD) or for WiMax-type uses (TDD).  To my knowledge, Agentschap’s auction was only the second time an auction was used to determine not just assignment but allocation as well.  In 2008, ComReg in Ireland used a very similar auction in the 26 GHz band.

Insight:  In a previous Cool Stuff, I wrote about my work to design an auction which could not determine not only who gets the spectrum rights, but what the contours of those rights are.  I called this approach: Price-Guided Radio Policy.  Now, we have two data points to suggest that this approach can work and can efficiently determine not only spectrum assignments but allocations as well.

Don't try to bend the spoon.

In the classic 1999 film The Matrix, the protagonist, Neo, played Keanu Reeves, goes to see an oracle.  In the waiting room, he happens upon one of the oracle’s child disciples who is sitting zazen and melting a metal spoon with mind.

Spoon boy: Do not try and bend the spoon. That’s impossible. Instead… only try to realize the truth.

Neo: What truth?

Spoon boy: There is no spoon.

Neo: There is no spoon?

Spoon boy: Then you’ll see, that it is not the spoon that bends, it is only yourself.  (Source IMDB)

By the same token, I have long wondered if there is no radio spectrum.  This fact is among the reasons that the unlicensed regime works so well.  It is spectrum policy, just without the spectrum

The jurisprudence underlying the Part 15 rules is that unlicensed spectrum is not spectrum at all…. It is merely an idea – a concept – a way of describing and organizing the physical world in our minds and in our actions. Spectrum is a legal and engineering construct to control for an immutable fundamental physical property… (Source: Unlicensed to Kill)

The Part 15 rules simply consider what is the maximum amount of irradiated power which can be emitted by a device without an unacceptable probability of causing harmful interference.

However, most of spectrum policy other than the Part 15 rules deals with regulating the “airwaves”.  Yet treating radio operations as spectrum or airwaves or property is a false paradigm.  This point was driven home to me a few years ago when I was an FCC staffer.  I was once filling out my timesheet at the FCC.  One of the lines on the sheet was “spectrum” and it dawned on me that I was spending more than 66.7% of my time dealing with something which had momentum, but no mass.  Somewhat paradoxically, electromagnetic energy behaves simultaneously like a wave and like a particle, carried by photons.  This is an important and powerful observation.  In fact, it was for this observation (the so-called photo-electric effect), and not General or Special Relativity, that Albert Einstein was awarded the Nobel Prize.

So, while we are regulating the airwaves, who is regulating the photons?!

Insight:  I raise this issue now because just last week the FCC announced the (re)establishment of its Spectrum Task Force.  Honestly, I am not exactly sure what implications for radio policy of considering the dually of electromagnetic radiation as both a wave and a particle might be; however, going forward perhaps the STF should undertake critical rethinking of this crucial policy area from the basics up.

Since we cannot bend the spoon, perhaps it is time we bend ourselves.

One of these is not like the others.

During a business trip to Japan last year, I traveled to Fukuoka to visit my good friend Prof. Toshiya Jitsuzumi.  (According to Wikipedia Fukuoka is Japan’s eighth most populous city and its second youngest).  Prof. Jitsuzumi invited me to give two talks: one to Kyushu University’s Faculty of Economics and one to his undergraduate students in communications economics.  To the undergraduates, I gave a lecture about the policy and economics of Next Generation Access Networks in the European Union.  I found Prof. Jitsuzumi’s students to be bright and engaging.  In the middle of the lecture, the students had some trouble understanding one of my stats on the number of homes passed by fibre optic access networks in the EU.  At first, I thought the confusion was due to my weak Japanese language skills.  After a bit of back and forth, I discovered the source of the confusion.  Prof Jitsuzumi’s students all have fibre optic connections to their homes.  I was the only one in the room who did not have a fibre optic Internet connection to his home (NB: I live in a suburb of Bonn, Germany).  The source of the confusion was that they were questioning why one would want to count homes passed.  This is not obvious if you and all your classmates  already has a fibre optic connection.

Insight: Granted Prof. Jitsuzumi’s class is not a representative sample set, but I can’t help feeling that the FCC is trying to catch the US up in ten years to where Japan is now.  From what I have been reading on the listservs, given current pace of deployment of FiOS and DOCSIS 3.0, the market will accomplish this goal on its own.  This fact begs the question what is need for governmental intervention.  Instead, the FCC should propose a more ambitious goal (one that might have a higher risk of failure) and devise a road map necessary for achieving that goal.  Perhaps this will come out in follow on work to National Broadband Plan.

I received a license, and my property rights all turned to commons.

I recently read Kevin Werbach’s excellent article on the TV white spaces, The Wasteland (not to be confused with T.S. Eliot’s The Waste Land).   I shared some of my ideas on his article with Kevin, and after an email exchange I came to the conclusion that there is a significant challenge to the successful opening up of the TV white spaces.

Under the White Spaces order, any unlicensed device which will operate in the band has to query a database and obtain permission before it can start transmitting.  Kevin argues that the white spaces database is independent of spectrum policy.  While that might be true, the imposition of the database will certainly hold implications for spectrum policy.  When a white spaces device has to query a database and obtain permission before it can operate, it is, by definition, no longer an unlicensed device.  Rather, the regime is a licensed commons.  This grant of permission is in fact a form of a license, albeit a light one.

Let me digress for a second.  A license is a grant of permission to do something.  It affords the right to “verb a noun”.  With a license one may: drive a car, own a dog, (try to) catch a fish, marry the woman of his (or her, depending on the state) dreams, or emit radio energy into the ether.  A spectrum license is usually coupled with some expectation of interference protection, but not always. The FCC already has utilized a myriad of different license types, including license-by-rule, operator, class, station, and geographic.  (I detail several different license types in my 2004 TPRC paper, at pp. 9-16.)

In my 2006 law review on Personal Communications Services (PCS), I examine both the licensed and unlicensed version of PCS.   The licensed commons is one of the factors which killed the unlicensed version PCS.  For unlicensed PCS, the FCC created a regime under which unlicensed users had to get permission from a non-profit firm called UTAM before they could start using their unlicensed PCS devices.  In doing so, the FCC inadvertently delegated to UTAM the power to grant licenses.

Think of the poster child for the unlicensed regime – Wi-Fi.  I can turn on my Wi-Fi anytime, anywhere, and leave it on until Ron Coase’s cows come home from grazing on the commons.  No grant of permission is required to access the spectrum (emit RF energy).  Now, consider a white spaces device.  When it turns on, it has to access a database somewhere and get the Okay to start emitting RF energy.  This is a grant of permission and is a form of a license, although the FCC has made Google or whoever is running the database is now the de facto licensor.

A licensed commons can be a very good thing.  Ham radio and the interstate highway system are both licensed commons and have both been very successful.  So, this type of arrangement can work in practice; however, when the alternative is less restrictive, the licensed system will not be desirable.  The FCC’s Part 15 rules are the international gold standard for unlicensed (and licensed-exempt) operation.  They are the one area where U.S. communications policy still clearly stands head and shoulders above the rest of the world.  The reason the Part 15 rules work so well is that it is spectrum policy without the spectrum (mathematically, spectrum policy – spectrum = Part 15).  The rules simply consider what is the maximum amount of irradiated power which can be emitted by a device without an unacceptable probability of causing harmful interference.  It is a classic efficiency approach and should be the basis of all radio operations.

In order for the White Spaces Order to be successful must offer device manufacturer and device users more benefit than they could achieve by using the existing Part 15 rules.  Device manufacturers can make devices to operate under the less restrictive parts of the Part 15 rules (the U-NII and spread spectrum rules).  So, they never made any successful products for U-PCS.   The same will be true for the White Space rules.  In order for the White Space database system to work, it will have to offer greater flexibility, more power, wider tuning ranges, more suitable frequency bands, etc. than the current Part 15 rules allow.

Insight:  Should the band not deliver on its promise punditocracy on the ‘property rights’ side of the spectrum policy debate will say: “I told you so – unlicensed never works.”  The sad irony is that if the White Spaces rules fail to deliver, it will not be because it is an unlicensed regime, but because it is truly a licensed regime.  I told you so, first.

Japan Communications built a really cool billing system to handle payment and authentication.  But, Japan Communications does not have a wireless network.  That it gets from the leading carrier NTT DoCoMo. Japan Communications leases capacity on DoCoMo’s network nationwide, and has the ability to purchase more capacity as this business grows. HP gets to determine which devices are sold and can sell the connectivity as its own.  Furthermore, Japan Communications could set up such a system to sell anyone else’s networked devices.  Say, how about a Carterfone?

While Japan Communications negotiated with DoCoMo to get on its network, it was able to do so because the Japanese Ministry for Communications and Information created which rules opened the networks of three largest wireless operators DoCoMo, KDDI, and SoftBank to wholesale. There was apparently a three-year battle at the Ministry in which Japan Communications was at the center. Japan’s policy to require wholesale access to wireless networks goes further than the US FCC’s rules for its 700 MHz auction which mandated these open these networks to foreign devices and handsets.

Insight: This seems like a really cool business model with implications for carriers, devices manufacturers, and application service providers around the world. I have said in a previous Cool Stuff, it is not a question of whether wireless networks should be open or closed. Rather, there is some optimal level of openness which will maximize the carrier’s return.  A privately determined level of openness will no doubt diverge from a level of openness which represents a public optimal. However, this begs the question whether opening networks to wholesale in this way is good policy and whether the Europe and the US should follow suit.  The answer is far more complex than can be addressed in a humble blog entry.  Nonetheless, I am curious see how this market will develop.

Source: Coneee, flickr.com, used under creative commons.

In the past week, there has been a lot of talk about the US federal government’s “Cash for Clunkers” program.  By most accounts, the program has been quite popular.  Indeed, the program’s original $1 billion in funding was exhausted in about two weeks, prompting Congress to vote another $2 billion for the program this past week.

Under the program, consumers can trade-in an old car which gets less than 18 MPG towards the purchase of a new car.  The consumer gets a credit equal to the scrap value of the car, plus $3,500 to $4,500.  The car dealership then takes the traded-in car, pours solvent into the engine to ruin the lubricating oil, and runs it until the engine seizes.  The car is then junked for scrap.  More than 230,000 cars have been traded in under the program so far.

Insight:  In junking the clunker cars, we are about to throw a whole bunch of babies out the bath water.  It consumes a tremendous about of  natural resources to produce an automobile.  So, while it is good to get a quarter million 18-MPG or less motors off of the road, it does not make sense to crush all of those cars to leave them to rust in a junk yard.  In fact, it is a bit of an environmental nightmare.

I suggest that the Cash for Clunkers Program consider a plan which permits rolling-up the clunkers, removing their seized engines, and converting the cars to electric vehciles.

Internal combustion engines have had their day, but sooner or later they will have to give way to a more efficient system.  Because of the ability to quickly replenish the vehicle’s energy supply with cheap oil, internal combustion engines are convenient, but they are truly wasteful. Internal combustion engines are perpetually trying to tear themselves apart from the inside and turn most of their chemical and kinetic energy to heat.

So, in light of not having to produce more steal and generate more waste in the production, the electrification of existing vehicles makes some sense. To electrify the cars, requires removing the internal combustion engine and the fuel system and replacing them with an electric motor and battery system.  Pretty much everything else in the cars stays.  The conversion to electric is not all that hard to do.  In fact, DIYers are already doing conversions in their garages – takes about 40 to 100 hours and good set of tools.  Nearly all electric cars are already conversions.  Even the macdaddy of electric vehicles – the Telsa Roadster – is just a pumped up Lotus Elise with better aerodynamics and giant cordless phone battery.  And, despite the fact that the clunkers used cars, they are still attractive for conversion.  Since an electric motor has a single moving part, a well-done electric conversion can be expected to last for over 1 million miles.  Further, used cars have already gone through a break-in period so there is a lot less friction in the bearings and drivetrains.

As a threshold problem, one would need to determine statistically which makes and models are being traded in as clunkers.  Further, one would have to determine, from an engineering stand point, which of the most makes and models could be converted to electric cars.  Finally, a business case would have to be completed in order to determine whether conversions of these vehicles could be done at minimum viable scale.

We can do this.  After all, we already own GM and it is idling factories and laying-off workers.

The electrified clunkers could then be sold a low cost to be used as daily commuter cars.  This would have a multiplier effect for both the economic and environmental dimensions of the program.

NB:  I do not argue that electric cars are an environmental panacea.  First, the electricity used to charge the cars has to be generated in a carbon-neutral way. Second, more than 90% the alloys need to make high efficiency electric motors comes from China.  This would have the effect of changing geopolitical power from oil-exporting countries to a single nation.  However, the present situation is unsustainable.