Category Archives: Economics

by | December 5, 2007 · 6:20 pm

The One Minute Case for Stock Shorting

What is stock shorting?

Stock shorting is a method of profiting from a decline in a stock’s price. It is the opposite of investing long, where the investor profits from a rise in the stock’s price. “Going long” or hoping for a gain in the stock’s price is the more familiar method of investing. However, “going short” and profiting from a decline in a stock’s price is an equally valid method of investing.

How does stock shorting work?

Shorting a stock is a little more complicated than going long where a stock is simply bought and then sold later for either a gain or loss. Shorting stock first involves borrowing it from an existing owner. The short seller pays a fee to the owner to borrow his shares. Upon borrowing it, the stock is immediately sold and the proceeds are kept in the short seller’s brokerage account. When the short seller wants to close out his position (or the shares’ owner wants them back), he buys equivalent stock in the marketplace and returns the shares he borrowed back to the owner.

If the stock has fallen in value, he makes a profit that is the difference between the price at which he borrowed the stock and the price at which he bought it back. Conversely, if the stock has risen in value, he suffers a loss since he has to buy back the stock at a higher price than he borrowed it for.

Short sellers fulfill a crucial and productive role in financial markets:

Short sellers bring to light valuable information about poorly run companies.

Short sellers have a strong incentive to uncover poorly run companies. If a short seller successfully discovers ahead of others that a company is destroying value through incompetence, bad luck or even criminal activity, he profits by shorting the stock and publicizing the information. Short sellers are similar to good investigative journalists. They make more money if they can “scoop” others with information that will drive the stock down.

It is this aspect of short selling that many company managers, regulators and others find discomforting. Yet these same managers and regulators have no problem when an investor uncovers a successful company. Why should they be opposed to someone who does the opposite, and uncovers the overvalued, incompetent, lazy or even fraudulently managed companies?

Short sellers help capital go to the best companies.

By taking financial capital away from poorly run companies, short sellers free up money that can go to the best-run companies. Short sellers are the other half of the value-creating process of financial markets whereby capital is continually re-directed to those who can put it to the most valuable use.  The existence of short sellers means that capital will more quickly flee the poorly run companies and thereby become available that much faster for the better-run companies. The profit that a short seller makes is his reward for aggressively uncovering the poorly run companies.

Short selling is challenging.

Short selling is not for everyone for the simple reason that stocks generally tend to go up. During the 20th century, stocks gained 9% a year on average, although there was significant yearly variation. Stocks do not decline in value across the board for long periods of time. Because of this, short sellers must time their moves well, and attempt to short at the top of a stock’s move and then close out the position when it has hit bottom. If the short seller mis-times his moves, he will lose money. Such precision in timing is less important for long investors because stocks generally go up.

It is a misconception that short sellers can unfairly cause stock prices to go down.

This is the most common misconception about short sellers. However, short selling is only likely to be successful if companies truly have problems. If a seller shorts a strong or improving company, he will lose money. It is a misconception to think that short sellers (or long investors) can cause stock prices to deviate for meaningful time periods from their true values.

The only power a short or long investor has comes from being right. When he is right, he is rewarded for helping to bring true information to the marketplace. When he is wrong, his wealth is dissipated and his ability to invest further is diminished. If he is wrong often enough, all of his wealth will be dissipated and his ability to influence stocks will be nullified.

Conclusion: Short selling is moral and should be permitted.

Short selling creates value by making the capital markets work more efficiently. Short sellers help bring negative information about companies to the market. By doing so, short sellers provide liquidity to the market and help capital to flow away from the worst companies and toward the best companies. Without short sellers, markets would be less liquid and more violatile. Long investors would have more difficulty selling their positions, and the lack of liquidity would make it more difficult for companies to raise funds in public offerings.

To restrict short selling not only harms the efficiency of the markets, but it violates the right of stock owners to freely dispose of their shares as they see fit. Because their shares belong to them, it is their property, they have the right to do what they want with them, including loan out their shares to short sellers. Conversely, short sellers have the right to borrow those shares.

A proper understanding of short selling demonstrates the valuable and productive role it plays in the financial markets.

Further reading

  • Investopedia: Short Selling: Introduction
  • Investopedia: Short Interest: What It Tells Us

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by | November 2, 2007 · 4:08 pm

The One Minute Case For Strict Civil Liability of the Justice System

What is the problem?

The growing use of non-lethal weapons such as tasers by the police has to calls to ban or restrict their use. The real issue being debated is the extent to which police officers should risk their safety to detain suspects. Should they only use force when someone’s life is in danger, or to avoid the risk of injury when attempting to tackle a suspect, or to avoid a sprain from having to run after someone? It is likely that further debate will result in a consensus enforced by the legislative and judicial branches of government. But what criteria should be used to determine the level of risk that police officers may be exposed to before using force?

Under the current system, police officers are only held responsible for injuring others only if found guilty of a miscarriage of justice, that is, willful malice or negligent behavior in the performance of their job. This provides an incentive for the judicial branch to minimize liability by maximizing the leeway officers have in deciding whether to use force. Furthermore, establishing standards for proper police procedure is a highly-non objective process, based on factors such as the public’s fear of police brutality, their desire for safety, the cost of lawsuits from police actions, and the political gain politicians find from pushing more or less draconian policies. One means of improving on this process is to establish a strict liability criteria for police actions.

What is strict liability?

Under a strict liability standard, it is not necessary to find a party guilty of malice or negligence, only of fault. Perpetrators of damages arising from inherently dangerous activities are responsible for damages regardless of whether they acted improperly. For instance, drivers at fault for damaging another car or injuring a driver are held financially responsible regardless of whether they acted maliciously or negligently. Under strict liability, a police agency would be held responsible for personal injury and property damage if an officer injures an innocent suspect, or unnecessarily injures a criminal — even if the officer acted properly in the performance of his duty. For example, an officer who fires at a guilty suspect who poses a real threat would not be liable, but an officer who fires at a suspect who does not pose a threat will be held liable for damages whether the officer is guilty of a miscarriage of duty or simply made an error in judgment. Furthermore, such a system would repay defendants who are exonerated at trial for their time and suffering.

Strict liability shifts incentives to the party best qualified to control costs

One objection to the strict liability standard is that it would greatly increase the financial risk faced by police departments and courts. However, by placing the burden of minimizing costs on the judicial agency, a strong incentive is created to minimize mistakes – and therefore costs. It is likely that police departments would attempt to insure themselves against risk, and the insurance agents would in turn establish guidelines that seek to minimize their risk. Such guidelines may ban tasers because of their health dangers – or they may require them in most situations where deadly weapons were formerly employed. Police agencies may prefer to hire men because they would find it easier to tackle suspects (and thus avoid a major incentive for taser use) or women because they are better at resolving conflicts peacefully. Because they would bear the cost of mistakes, police agencies would be motivated to experiment on the most effective way to perform their jobs, while the public they protect would be financially shielded from their mistakes by a strict liability standard.

Strict liability discourages prosecution of victimless crimes

Another objection to strict liability under the current legal framework is that it would make police agencies averse to enforcing laws that are prone to mistakes or unsuccessful prosecutions – namely, those known as “victimless crimes.” Adultery, gambling, homosexuality, and the trade of illicit substances and goods are areas where the lack of a victim makes errors in suspect identification and successful prosecutions especially likely. This is especially true of laws pushed by vocal voters on unwilling recipients – for example, communities that favor drug or alcohol prohibition on communities that tolerate drug and alcohol users. Yet this only illustrates the insulation of government policies (and by extension taxpayers) from the cost of economically expensive (and thus socially destructive) laws. If enforcement agencies are required to pay for their mistakes, they will favor laws that can be objectively enforced, and violations of which result in victims pushing for enforcement.

Further reading

  • Civil Liability for Government Wrongdoing

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by | October 2, 2007 · 3:18 pm

The One Minute Case for the Austrian Business Cycle Theory

The Austrian Business Cycle Theory was developed by the economist Ludwig von Mises to explain the phenomenon of business cycles. It provides crucial insight for understanding the cause of cyclical boom/bust cycles and their connection the government’s manipulation of the economy. To understand the Austrian Business Cycle Theory, an analogy is helpful:

Imagine an economy with just one actor: Robinson Crusoe on an island. Crusoe loves fish, so he spends half of each day fishing so he can enjoy fish in the evenings. Additionally, Crusoe spends Friday mornings maintaining his fishing dinghy and nets. In order to have fish on Friday, he must fish for an extra hour every other day of the week. In economic terms, Crusoe has a savings rate of one hour per day. His savings rate is also his investment rate, or the percentage of present income he sets aside to maintain or increase future consumption.1

Crusoe doesn’t have a fridge, so he preserves his catch by throwing it in a small, dark pond. He can’t see how many fish are in the pond, so he keeps a stack of small rocks near it. Every time he adds a fish, he adds a rock, and every time he eats one, he removes one. The rocks are his money supply.

Suppose that Crusoe shares the island with some mischievous monkeys, who see Crusoe adding rocks to his pile. They decide to imitate him, so every time Crusoe ads a rock, they sneak in and add one as well. The monkeys are inflating the money supply by injecting currency into Crusoe’s investment fund.2

One day, Crusoe suddenly notices that his “savings rate” of fish is double the usual. He decides to compensate by eating some of the fish he catches during the “savings hour.” This is the consumption-side of the boom phase of the business cycle. Crusoe also decides to take some extra time each day to start building himself a new hut. This is the investment-side of the boom phase of the business cycle.

Crusoe now believes that the cost of saving fish is half the usual, while in fact his savings rate is too low for the investments he is planning.

Before long, Friday comes around. When it comes time to eat his midday meal, Crusoe suddenly realizes that he’s out of fish – despite having a surplus of rocks. He’s exhausted his investment capital because the additional currency snuck into his money supply did not represent a real increase in his productivity or savings rate. He doesn’t have the capital (fish) to maintain his previous consumption rate, much less increase it. He is forced to cut his investment rate (he must spend some of his Friday fishing) just to have some fish for Friday’s dinner. He must also abandon his incomplete hut because he does not have the time to finish it. The abandoned hut is an extravagant expenditure that represents a loss of capital.3 This is the bust phase of the business cycle.

To review, here’s the overall impact of the monkey’s trickery: Sunday-Friday, Crusoe catches the same number of fish, but consumes more, and therefore saves less. That’s the boom period. Friday, Crusoe consumes less fish, and spends less time for maintaining his nets (capital). Some of his investment/consumption time must now be spent in production. That’s the bust period. If Crusoe’s initial savings rate allows him to just break even each week 4, his nets will gradually get worse and worse and he will eventually go hungry.5

Notes

  1. Crusoe prefers to enjoy his fish sooner rather than later, but he is willing to put aside some of his catch to get more fish later. The discount he gives to eating a fish Friday is his time preference, or his originary interest rate. (To that, he adds the risk that the fish will spoil by Friday to get the market or “real” interest rate.)
  2. As long as the monkeys keep contributing one stone for every fish, Crusoe can account for their trickery. But if the monkeys are unpredictable, it will be impossible for Crusoe to set the proper savings rate.In the real world, the originary interest rate reflects the average time preference of all savers. If someone starts monkeying around with the interest rates, it becomes impossible for investors (or the monkeys at the Fed) to know what the real rate of savings is even if they know that the rate is being manipulated.
  3. That abandoned hut represents investments which exceed the ability of the actual savings rate to complete. The resources it takes to build compete with worthwhile investments (such as repairing the fishing nets) by raising the prices for all capital. Ridiculous business models and sky-high salaries during the dot-com boom, as well as over-extended sub-prime mortgages likewise compete with legitimate business models, salaries, and mortgages. Manipulating the money supply makes it difficult to distinguish bad investments from good ones, so no one can escape the inevitable crunch.
  4. That is, zero net profit, an equilibrium rate of savings, or “the evenly rotating economy” in Mises’ terminology.
  5. Suppose Crusoe decides to ignore his hunger and work on his nets all Friday. In other words, he trades current production (and therefore consumption) for higher future consumption (that is, economic growth). If he does so voluntarily, there’s nothing wrong with that. But there’s nothing inherently more desirable or efficient in spending some of one’s time starving just to increase future production (that is, in valuing economic growth over present consumption.) Note that the longer Crusoe delays the shift back to production, the more severe the miss-allocation of resources (and his hunger) becomes. The monkey’s trickery does not actually make Crusoe to become a better saver – he is more likely to start saving less because of uncertainty over the future.

Further reading

  • Austrian Business Cycle Theory: A Brief Explanation
  • The Austrian Business Cycle Theory at Mises.org

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by | July 10, 2007 · 7:47 pm

The One Minute Case For Advertising

Why defend advertising?

While the abundance of advertising is usually viewed as a sign of the vitality of capitalism, it is nevertheless under a near-universal assault by intellectuals. Because advertising “blatantly and unapologetically appeals to the self-interest of consumers for the blatant and selfish gain of capitalists”1, attacks on advertising are an assault on capitalism and ethical egoism. Arguments against advertising usually take two forms: the argument is that advertising is economically inefficient and the argument that advertising is somehow coercive. 2

The myth of “perfect competition”

Most economic arguments against advertising derive from the theory of “perfect competition, ” which is an ideal state against which markets are to be judged. This state is characterized by homogeneous products, relatively small sellers without monopoly power, prices which approach the cost of goods, consumers who have perfect information about all products and prices, and no entry costs to markets.

Advertising violates all these conditions, mainstream economists argue. Advertising seeks to establish product loyalty, and therefore to make certain brands more valuable than others. This creates barriers to entry by giving companies monopoly privileges, and allows them to price goods above cost. Furthermore, advertising is an imperfect and biased way of communicating product information to consumers. Finally, advertising retards progress by making it more expensive for new producers to enter the market.

In the real world, markets work quite differently: the essential characteristic of capitalism is the entrepreneurs who invest capital in new services, products, technologies, and businesses models. When their predictions are right, they gain a temporary advantage over their competition and turn a profit; when they are wrong, they take a loss. Success in business requires continual insight into which investments will prove profitable.

Rather than being a barrier to entry, advertising makes competition possible. New businesses and products stimulate demand by announcing their benefits to consumers. Expanding demand makes goods cheaper by creating economies of scale. While advertising is often attacked for creating demand for shoddy goods, it is not sufficient to advertise to gain consumer loyalty – only positive customer experience and continued positive goodwill can do that. Advertising is what allows new market entrants to capitalize on consumer dissatisfaction and dislodge established firms, as Japanese auto makers did when they demonstrated the superior value and quality of their cars over American ones.

The perfect competition model assumes that competing companies automatically lower prices to match their competitors. In reality, no business wants to lower prices unless consumers expect them – and it is advertising which performs that role by educating consumers about the competition. Advertising itself is a check on high marketing budgets: as consumers become better educated, competitive pressure creates price wars which force businesses to minimize expenses. 3

Yet another criticism is that advertising is a biased method of consumer education. Yet the continued importance of advertising as an influence on buyers proves that the creator of a good is the party most qualified to communicate the value proposition it offers, whether directly or through an intermediary. While word-of-mouth reports and independent product testing organizations are essential sources of consumer education, competitive pressure through advertising provides the claims whose veracity they evaluate.

Advertising is non-coercive

Opponents of “consumerism” often claim that advertising creates its own demand. But a commercial cannot simply implant a desire in the viewer. Rather, advertising tells consumers how their existing values can be satisfied in a particular concrete form. Some advertisements seek to meet well-defined values: toothpaste for clean teeth. Others educate consumers about products which fill a specific need: sports drinks for athletes, or diet colas for the health-conscious. Some advertising functions much like art, and present a concretization of highly abstract or subconscious values. For example, a sports car commercial may appeals to consumers who seek independence and efficiency, while a luxury sedan commercial might appeal to those who value comfort and elegance. Attacking advertising solely for appealing to emotions is as silly as criticizing a painting or a movie for appealing to the viewers’ emotion rather than presenting a dry, factual account.

Ultimately, advertising is a public appeal to the mutual self-interest of the seller and buyer. Movements to silence or limit advertising seek to regulate the freedom of the individual to voluntarily interact with others, and therefore are an assault on both freedom of speech and the right of association.

References:

  1. Google Books: Jerry Kirkpatrick: In Defense of Advertising: Arguments from Reason, Ethical Egoism, and Laissez-Faire Capitalism.
  2. The Five (Wrongheaded) Complaints against Advertising by Jerry Kirkpatrick
  3. Persistently high advertising budgets are indications of high barriers to entry, usually due to government interference. For example, in the case of drug companies, the FDA forces drug makers to spend up to a billion dollars to deliver a single drug to market. This limits the drug market to all but the largest companies and most profitable medicines. Prescription drugs have large advertising budgets because the legal barriers to entry make it prohibitively expensive to compete on price or quality, or to appeal to smaller markets such as rare diseases.

Further reading:

  • Advertising is Good Medicine by Wayne Dunn
  • A philosophic defense of Advertising by Jerry Kirkpatrick
  • The Concise Guide To Economics: Advertising

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by | June 26, 2007 · 4:15 pm

The One Minute Case Against Socialized Healthcare

There is no right to healthcare

The United States was founded with the declaration that all men have the right to “life, liberty, and the pursuit of happiness.” The Founders recognized that all men have a moral right to be free from the coercion of others, as long as they allow others the same freedom. They believed that rights do not impose a positive obligation on others, but only the negative obligation to restrain from the initiation of force.

The claim that there is a “right to healthcare” violates the principle of individual rights because it requires that the liberty of doctors and the property of taxpayers be violated to provide for others.

The myth of “free” healthcare

It is a common belief that when government provides something, it is free or cheap. But politicians cannot create wealth – they can only redistribute it. Money for all government spending comes from business – whether by entrepreneurial investment, the wages of patients, or taxes.

Whether by price controls of outright nationalization, when governments make prices artificially low, demand skyrockets, and shortages result. Politicians respond by passing ever more regulations to control costs. These regulations stifle innovation, drive up costs, and force healthcare providers out of business. The end result is to replace capitalism, the greatest wealth-generating system known to man, with an onerous system of central planning.

Capitalism cannot guarantee that all our medical needs will be provided for – no system can do that. But it does give entrepreneurs the incentive to compete to provide the best possible service they can. Centralized socialized systems have no incentive to improve service or to try bold new techniques. Politicians can force prices to be artificially low, but they cannot lower costs – they can only drive doctors, hospitals, and drug companies out of business.

The victims of “universal” healthcare

The waiting time for treatment in Canada varies from 14 to 30 weeks. Waiting lists for diagnostic procedures range from two to 24 weeks. Some patients die while waiting for treatment. To stop sick people from circumventing the “free” system, the government of British Columbia enacted Bill 82 in 2003, which makes it illegal to pay for private surgery. Patients waiting for critical procedures are now forced to seek procedures in the U.S. and doctors are abandoning Canada in droves. Cleveland, Ohio is now Canada’s hip-replacement center. Ontario is turning nurses into doctors to replace some of the 10,000 doctors who left Canada in the 1990’s. 1 2

What will patients do when it is illegal to seek private medical treatment in the U.S.? Politicians are already working towards that goal. State and federal regulation impose onerous regulations which forbid insurance companies from offering services such as basic coverage for emergencies by requiring coverage of many types of procedures. Medicare forces doctors to follow 130,000 pages of regulations. Critics often attack the “capitalist” nature of American health care system. The reality is that the government now pays for 50% of health care, and closely regulates the rest.

Healthcare is only affordable under capitalism

If a society is not wealthy enough to afford healthcare, health socialism will not make it richer. Cuba, a poster child of socialist healthcare schemes, spends $229 on healthcare per person each year, while the U.S. spends $ 6,096.3 Premium services are available only to paying foreigners, while natives must bribe doctors for timely treatment and bring their own towels, bed sheets, soap, food, and even sutures.4

A government can decide to replace individual choice with state-mandated decisions of what goods and services are more important for the “common good.” But it can only spend on one area at the expense of another. If Cubans are not totally deprived of medical treatment, it can only be at the expense of all other goods. A doctor’s salary in Cuba is 1.5 times the median at $15-20 per month. 5 A telling sign of their deprivation is the Cuban suicide rate, which is the highest in Latin America and among the highest in world. Cubans in Miami on the other hand, kill themselves less often than other Miamians.6 When they risk their lives in leaky boats to escape to the U.S., the right to make their own decisions regarding their health is among the freedoms they hope to gain.

References:

  1. “Free Health Care in Canada” by Walter Williams
  2. “Do We Want Socialized Medicine?” by Walter Williams
  3. Reuters: Health care in Cuba more complicated than on SiCKO
  4. BBC: Keeping Cuba Healthy by John Harris
  5. “An Evaluation of Four Decades of Cuban Healthcare” by Felipe Eduardo Sixto (PDF)
  6. Miami Herald: “Study: Suicide epidemic exists under Castro” by Juan O. Tamayo

Further reading:

  • Moral Health Care vs. “Universal Health Care” by Lin Zinser and Dr. Paul Hsieh
  • Health Care Is Not a Right by Leonard Peikoff, Ph.D.
  • Health Care Is a Business—or Should Be by Richard E. Ralston
  • Video: Unisured in America (Free Market Cure Documentary Series)
  • Americans for Free Choice in Medicine
  • American Health Care: Essential Principles and Common Fallacies
  • FIRM: Freedom and Individual Rights in Medicine
  • The “Cost” of Medical Care by Thomas Sowell
  • Michael Moore’s Shticko by Michael C. Moynihan
  • NY Times: “As Canada’s Slow-Motion Public Health System Falters, Private Medical Care Is Surging“
  • Do fat people deserve medical treatment?
  • The One Minute Case for Individual Rights

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by | June 11, 2007 · 11:44 pm

The One Minute Case Against Software Patents

The cost of software patents

One prominent form of patent abuse is “submarine patents” – patents which lie dormant until someone discovers their similarity to a popular technology. The patent on the GIF image format surfaced a decade after its widespread adoption on the web. The Eolas patent on web browser plug-ins cost Microsoft $521 million and forced tens of millions of web pages to be crippled or redesigned. The RIM patent cost Blackberry $612.5 million and nearly shut down service to millions of people despite the patent itself being invalidated.

Software patents are becoming a major threat to the software industry. The risk of software patent lawsuits forces software companies to obtain defensive patents in order to obtain cross-licensing agreements and discourage patent lawsuits through the threat of counter- suits. An entire industry of patent trolls extorts businesses with bogus patents by taking advantage of the fact that many businesses prefer to pay licensing fees than go to court.

The problem of software patent enforcement

A software algorithm is an abstract description of a general way to solve a problem, such as a mathematical formula. Many algorithms are popular because programmers have found them to be useful in different fields. Algorithms, such as sorting lists and organizing shopping carts are widely recognized as non-patentable. But how can one distinguish obvious ideas from patentable ones? Does the application of an existing algorithm to a new field deserve a patent?

Software patents cripple software development

Software patents make software development risky because it is so difficult to know whether an idea has been implemented before. Over the years, millions of software programs have been written using billions of algorithms. Is it not feasible to have to study thousands of patents to make sure one does not violate the rights of others, while at the same time designing an integrated product. As a consequence, innovative companies are faced with the constant threat of discontinuing products or paying enormous amounts.

The success of companies such as Microsoft, Oracle, SAP, and Apple was not due to monopolizing certain features, but on continually improving on each other’s innovations. In a 1991 memo, Bill Gates wrote

If people had understood how patents would be granted when most of today’s ideas were invented and had taken out patents, the industry would be at a complete standstill today…The solution is patenting as much as we can. A future startup with no patents of its own will be forced to pay whatever price the giants choose to impose. That price might be high. Established companies have an interest in excluding future competitors.

Copyrights are a superior alternative to software patents

The same legal principle that protects a book, song, or painting, automatically protects computer programs by forbidding copying or close paraphrasing of the code. Copyrights are straightforward to enforce because it is easy to identify what is being protected: a particular implementation of a set of algorithms to solve a problem, rather than the algorithm itself. They have the advantage of being automatic, free, and only useful against criminals. Copyrights allow the abstract ideas behind a software problem to be created by anyone, but protect an implementation of those ideas in concrete form, so developers who implement their own ideas do not have to worry that someone will put them out of business.

The protection of property rights requires standards that can be objectively enforced. Attempts to protect rights without the guideline of objective criteria will only violate real rights and nullify the benefit of protection.

Further reading:

  • Microsoft takes on Linux
  • Wikipedia: Arguments against software patents
  • League for Programming Freedom: software patents
  • The Letters of Thomas Jefferson: 1743-1826 No Patents on Ideas

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by | June 8, 2007 · 5:30 pm

The One Minute Case Against “Net Neutrality”

What is “net neutrality?”

To borrow Senator Ted Stevens’s infamous analogy of the Internet to a series of tubes, imagine a network of pipes connected by switching stations. The width of a pipe (bandwidth) determines the volume of messages (packets) than can be sent through it. Packets arriving at a switching station wait in a queue until they can be forwarded to their destination. The pipe’s diameter and the volume of traffic determines the total time (latency) that messages take to reach their destination.

Advocates of “net neutrality” argue against the right of the owners of the pipes (Internet Service Providers) to discriminate between different messages or to charge recipients of messages. So for example, an ISP would not be able to favor telephone calls sent over the net over movie downloads, or charge Google extra for the traffic sent their way, or to block a business if it competes with their own services, or to block malicious or illegal websites. Implementation of such regulations would require government surveillance of Internet traffic and FCC approval of new technologies and services which might violate “neutrality.”

Regulation stifles innovation

The limitations of the original Internet protocols became apparent as it transitioned from a monopoly network designed for government use to a competitive and decentralized marketplace. One limitation is the lack of ability to prioritize certain kinds of traffic. Different kinds of communications have different bandwidth requirements. Watching movies over the web is bandwidth-intensive, but not time-critical. Teleconferences are both bandwidth intensive and time critical. Some applications like remote surgery and other time-critical services are simply impossible over the public Internet with current technology.

Advances in technology are beginning to allow traffic to be analyzed in the process of transmission, so certain traffic, such as real-time video can be prioritized, while other traffic such as file sharing or spam can be given a lower priority or dropped. Along with dramatic increases in speed and performance, technological innovation is making entirely new kinds of services possible.

Net neutrality advocates want the government to regulate how ISP’s may and may not route traffic. Pressure groups such as consumer activist groups, major websites, small ISPs, and Internet backbone providers are fighting for controls that favor them. Once the precedent of regulation is established, competition will shift to passing the most favorable legislation rather than providing the best technology and service.

Regulations breed more regulations

While communications technology has experienced exponential growth, heavily regulated and monopolized consumer phone and cable providers have been slower to improve services. Consumers fed up with expensive cable and DSL services are demanding more government controls over the pricing and behavior of their ISP’s. They argue that regulations are necessary because telecommunications companies receive monopoly privileges and other benefits from the government. But the lesson they should learn is the opposite – regulations create the need for more regulations. The solution is to abolish coercive monopolies for cable and phone service providers and allow free and open competition.

The Internet is possible because many private networks find it in their mutual self-interest to cooperate and share traffic loads. When inequalities arise, networks compensate each other for the extra load. “Neutrality” regulations force companies to act against their self-interest, inevitably leading them to complain to Congress to impose ever more detailed controls to maintain “fairness.”

The Internet is private property

The Internet is not public property. Telecommunications companies have spent billions of dollars on network infrastructure all over the world. They did so in the hope of selling communications services to customers willing to pay for them. The government has no right to effectively nationalize ISP’s by telling them how run their networks.

Proponents of a mixed economy like to invent hypothetical scenarios of ways companies could abuse customers. It is true that a free society gives people the freedom to be stupid, wrong, and malicious. The great thing about capitalism is that it also gives people the freedom for the most consumer-friendly business to win.  A regulated Internet takes away that freedom and turn it over to politicians and lobbyists.   History shows that most attempts to improve outcomes by regulating markets worsen the very problems they were intended to solve.    That is how the USA ended up with the current overpriced, monopolistic oligopoly providers.  Why do “net neutrality” advocates ridicule politicians for comparing the Internet to a “series of tubes,” and then trust them to regulate it?

Real solutions to a better Internet 

  • End local Internet monopolies which prevent small ISPs from being successful
  • Remove local and federal (FCC) regulations which prevent all but the most powerful corporations from providing telecom services
  • Allow ISPs to innovate in by forcing cities to open up their infrastructure  without the threat that their business model will be nationalized or regulated out of existence.
  • Give capitalism and free markets a chance – America has already tried everything else

Further reading:

  • “Net Neutrality: Toward a Stupid Internet” by Raymond C. Niles
  • Don’t Break the Net
  • “A rational debate on Net Neutrality” by George Ou
  • NetCompetition

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