Bandwidth for the People

Published March 1, 2005

Broadband stands to be a tremendous boon to economic growth. Consumers benefit from new ways to acquire information, enjoy audio and video entertainment, monitor remote locations, receive medical care, and buy items ranging from books to cars.

A 2001 study by Crandall (one of the authors of this article) and Charles L. Jackson estimated that universal broadband adoption could ultimately yield annual consumer benefits of $300 billion. Businesses, meanwhile, could reduce costs by $125 billion to $250 billion annually while increasing competition by making it easier for consumers to compare prices and services.

As state and national policies develop in response, it is important for policymakers to understand the costs and benefits of different approaches aimed at promoting the expansion of broadband Internet access.

Americans receive broadband Internet access primarily through coaxial systems from cable television companies and digital subscriber lines (DSL) from traditional telephone networks. High-speed access is also increasingly available over new wireless technologies, including Wi-Fi, mobile cellular networks, and satellite services.

The popularity of broadband has increased over the past few years. Prices have come down, and the number of applications that use broadband has increased. By the end of 2003, the FCC estimated there were more than 28 million subscribers to some form of broadband Internet service. In nearly 75 percent of all zip codes, there were at least two companies providing high-speed service.

Policy Options

Economic policy should address market failures. One type of market failure can arise if a firm has a dominant position that gives it the ability to block entry by competitors. A second type of market failure could arise if a critical mass of users is needed to make it worthwhile to develop new applications that would make use of broadband’s faster service. Even if such market failures exist, however, government should intervene only when the expected benefits of doing so outweigh the potential costs.

Regarding the potential market failure–market structure–there is little reason to believe any telecommunications firm has a truly dominant position today in providing broadband access.

Until recently, local telephone companies were required to make their entire networks–including broadband facilities–available to competitors. The rationale for this regulation was that the local telephone companies were considered to be “dominant” providers, and thus competition would be “impaired” if new entrants did not have access to all of the incumbents’ facilities.

Yet even as early as 2001, the FCC noted, “residential broadband services … while still a nascent market, generally appear to be subject to significant intermodal competition.”

In an August 2003 decision, the FCC began moving away from network-sharing regulations, loosening some unbundling requirements by eliminating the right of entrants to share the incumbents’ lines at very low prices. Telephone companies no longer will have to give competitors access to most new broadband investments. That means increasing incentives to invest in new infrastructure such as optical fiber to homes, which will provide faster data transmission capabilities than is possible over copper lines.

Over time, competition among providers using their own distinct infrastructure is more likely to lead to real competition over a wider range of activities than is competition created by forced sharing of facilities. Facilities-based competition can drive investment, particularly for network upgrades required to provide higher-speed broadband.

Universal Service Subsidies

The market for broadband and for services associated with its use is characterized by positive externalities. Suppliers of applications that require broadband will be more inclined to invest in those applications the more broadband users there are. Similarly, consumers will be more inclined to demand broadband the more ways there are to use it productively. The existence of these externalities suggests the market might not provide optimal broadband service and that, in principle, there could be a reason for government to subsidize or otherwise provide financial incentives for broadband rollout.

We believe, however, that robust competition is the essential engine for delivering the menu of broadband services and prices that consumers and businesses want. While positive externalities clearly exist, similar issues arise in many information technology contexts. Many of those markets, however, work quite well without government intervention.

Take, for example, the online auction market or the market for online gaming. Those markets also demonstrate externalities: The benefits generated by an additional user are larger than those that accrue to the user himself. Even so, few would seriously argue the government should subsidize eBay or fund the next generation of Doom.

Nonetheless, for political reasons it is possible the government may consider a subsidy for broadband. If the government moves in this direction, it should keep several points in mind. Most generally, subsidies should actually result in a change of behavior in the desired direction, rather than support current behavior. They should be targeted appropriately.

Discriminatory Taxes

Telecommunications services are taxed in a variety of ways, and scholars generally see those taxes as inefficient and costly to the economy. There is little reason to believe taxes on broadband access would be any more efficient than other telecommunications taxes.

Determining the effects of taxes on penetration requires knowing how price-sensitive consumers are for broadband service. One study using data from 2001 concluded that a 10 percent price increase would, all else equal, reduce broadband demand by about 12 percent. Likewise, a study using data from the 2000-era broadband market found that taxing Internet access could slow rates of innovation and adoption and even deter entry into the market.

Building on a Good Start

Public policies toward the Internet are important in helping to achieve the goal of greater broadband access, but those policies should be of a deregulatory, not interventionist, nature as this competitive market undergoes rapid growth and technological change.

Completing recent deregulatory efforts initiated by the FCC last year–that is, removing price and unbundling regulations–could help increase the diffusion of broadband by increasing investment incentives. Indeed, that is probably the best thing regulators can do to promote the economic rollout of broadband.

The authors are scholars at the American Enterprise Institute-Brookings Joint Center for Regulatory Studies (