“I don’t think that critics are seriously thinking through the economics of Internet service before they speak,” says Eli Dourado of people like me who are worried about the anticompetitive implications of Comcast’s bandwidth cap. He patiently explains that economic theory tells us that discriminatory pricing by a monopolistic content provider, in which inelastic customers pay more than elastic ones, is provably more efficient than a one-size-fits-all pricing regime.
I have no doubt Eli has an economic model that can back up that claim. But I also think it’s a good example of a kind of persistent myopia that afflicts the economic profession. Economists love to construct stylized models that allow them to draw mathematically rigorous conclusions about the world. The problem is that there’s an inherent bias toward models that are mathematically tractable over those that actually correspond to the real world.
Probably the best critic of this kind of thinking was F.A. Hayek. In a famous 1945 essay, he pointed out that many of the economic models of his day made unrealistic assumptions about the infallibility of economic decision makers:
What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic…
This, however, is emphatically not the economic problem which society faces. And the economic calculus which we have developed to solve this logical problem, though an important step toward the solution of the economic problem of society, does not yet provide an answer to it. The reason for this is that the “data” from which the economic calculus starts are never for the whole society “given” to a single mind which could work out the implications and can never be so given.
Eli’s argument for the superiority of price discrimination has much the same character. If we assume that each consumer knows what content he wants to watch and attached a fixed value to it, and if we assume that cable companies can reliably determine which content consumers want to watch, and if we assume that the transaction costs of licensing and redistributing that content are negligible, then we can mathematically prove that a vertically integrated cable monopoly can satisfy those user preferences at least as efficiently as a decentralized market featuring competing Internet video services reaching the consumer via a “neutral” broadband connection.
But this is emphatically not the economic problem facing the broadband market. Consumers have radically heterogenous tastes, and indeed they often don’t know they want to see a particular program until it’s offered to them. Cable companies are not perfectly rational actors, they are often sclerotic bureaucracies strongly biased toward the status quo and large content companies. The transaction costs of getting carriage on a major cable system are radically higher than the transaction costs of providing video content directly to consumers via the Internet, meaning that niche content and services are at a systematic disadvantage on proprietary video systems.
In short, a market involving numerous competing over-the-top video providers will be fundamentally, qualitatively different from a market in which one or two large broadband incumbents decides which video content to provide to consumers. In the long run, the open Internet is likely to offer a radically broader range of video content than any single cable company’s proprietary video service, just as is true for text and audio content today. But Eli’s model can’t accomodate this difference, because it requires us to treat content as homogenous and service providers as omniscient in order to make the math tractable.
“The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess,” Hayek wrote. The same point applies to the Internet. Its value comes from a lack of gatekeepers; anyone can transmit information to anyone else, and over time the best content rises to the surface through a process of decentralized competition. No central planner, even one as wise and benevolent as Comcast, could possibly do as good a job of delivering to consumers the content they’re most likely to enjoy. So while a competitive market for Internet video may be no more efficient than a cable monopoly in some economic models, I think that’s mostly a reflection of economists’ superficial conception of efficiency.