Tag Archives: Internet

The Great Disintermediation

Yesterday at Forbes, William Pentland had an interesting piece on possible disintermediation in the electricity market.

In New York and New England, the price of electricity is a function of the cost of natural gas plus the cost of the poles and wires that carry electrons from remotely-sited power plants to end users. It is not unusual for customers to spend two dollars on poles and wires for every dollar they spend on electrons.

The poles and wires that once reduced the price of electricity for end users are now doing the opposite. To make matters worse, electricity supplied through the power grid is frequently less reliable than electricity generated onsite. In other words, rather than adding value in the form of enhanced reliability, the poles and wires diminish the reliability of electricity.

If two thirds of the cost of electricity is the distribution mechanism, then, as Pentland notes, there is a palpable opportunity to switch to at-home electricity generation. Some combination of solar power, batteries, and natural gas-fired backup generators could displace the grid entirely for some customers. And if I understand my electricity economics correctly, if a significant fraction of customers go off-grid, the fixed cost of maintaining the grid will be split over fewer remaining customers, making centrally-generated electricity even more expensive. The market for such electricity could quickly unravel.

While it remains to be seen whether electricity generation will indeed become decentralized, such disintermediation would be the continuation of a decades-long social trend. It all began (plausibly) in 1984. The Macintosh was released, and desktop computing became a thing. Desktop printers disintermediated printing departments, Kinkos, and the steno pool. The Internet has disintermediated telephone companies, music labels, television networks, newspapers, and much more. Online education is unbundling university courses.

What’s even more exciting is the next generation of disintermediating technologies. Bitcoin could displace some financial institutions—to varying degrees, banks, the Federal Reserve, Western Union, and credit card companies. Mesh networks could solve the last-mile problem of Internet service delivery, which tends to be monopolized or at least concentrated. 3D printers could disintermediate supply chains. 3D chemical printers could disintermediate drug companies and the FDA.

Delivery drones like Amazon Prime Air‘s arguably disrupt package delivery services, though not entirely because FedEx and UPS will still run drone-utilizing distribution networks. More importantly, delivery drones disintermediate the real estate market for small businesses. It will no longer be important, if you run a local business, to have a storefront in a prime location. Your customers can order online and items can be delivered to them in half an hour straight from the factory or artisanal workshop. It could be the Etsyfication of the economy.

If information, electricity, money, and production all get disintermediated, what is left? If these trends continue, the future will be one in which human interaction is unmediated, and to a surprising degree, unregulable. It will be difficult to stop a willing buyer and seller from transacting. Information about the proposed transaction might not be censorable. Payment via Bitcoin or other cryptocurrencies can’t be stopped. Production and delivery of the item may be difficult or impossible to detect and intercept.

Intermediaries are often used by governments as points of control. As we shed intermediaries, it may become possible to live one’s entire life without any particular authority even knowing that one exists. I doubt that we’ll ever get that far in the process, because using non-abusive intermediaries often makes economic sense. But for the next few decades, at least, I expect the trend to continue and the world to get a lot more interesting.

The New WCITLeaks

Today, Jerry and I are pleased to announce a major update to WCITLeaks.org, our project to bring transparency to the ITU’s World Conference on International Telecommunications (WCIT, pronounced wicket).

If you haven’t been following along, WCIT is an upcoming treaty conference to update the International Telecommunication Regulations (ITRs), which currently govern some parts of the international telephone system, as well as other antiquated communication methods, like telegraphs. There has been a push from some ITU member states to bring some aspects of Internet policy into the ITRs for the first time.

We started WCITLeaks.org to provide a public hosting platform for people with access to secret ITU documents. We think that if ITU member states want to discuss the future of the Internet, they need to do so on an open and transparent basis, not behind closed doors.

Today, we’re taking our critique one step further. Input into the WCIT process has been dominated by member states and private industry. We believe it is important that civil society have its say as well. That is why we are launching a new section of the site devoted to policy analysis and advocacy resources. We want the public to have the very best information from a broad spectrum of civil society, not just whatever information most serves interests of the ITU, member states, and trade associations.

At the same time, we’re not backing off from our original position. We think the ITU’s policy of keeping WCIT-related documents secret is becoming increasingly untenable. We received an email from the ITU’s press office yesterday announcing a global press briefing. Here is what it said:

As the conference approaches, there is quite a lot of misinformation being circulated concerning the agenda and process of the conference. Join this global discussion to find out what’s REALLY going to be discussed, and how the process of proposals and debates operates to ensure a global consensus among all countries.

Misinformation, they claim—about documents the ITU keeps secret. If the ITU and its client states have nothing to hide, why are they keeping information from the public? The best way to fight misinformation is with transparency. We call on the ITU and its member states to make all documents associated with global telecommunications available to the public.

We could also use your help. Please help us spread the word about WCITLeaks to anyone who may be interested. In addition, we ask our users around the world to apply pressure to their governments to make their documents publicly available. Finally, please make good use of our new resources section; it is vital for the future of the Internet that the global citizenry be well-informed about potential threats to the free flow of information.

What Would Stateless Internet Courts Be Like?

Last year I wrote that there are benefits to operating a business that is subject to state law. As Schelling says, the right to be sued is the power to make a promise. Increasingly, however, there seems to be interest in running profit-making internet ventures that are immune to state control. There may be a market, therefore, for a private court that accommodates such activity. In this post, I’ll present an outline of what such a court might be like.

There are a number of private arbitration firms in the world, but in general they are not suited to deal with stateless actors, particularly those who wish to avoid state control altogether. First, they themselves rely on state law to a large extent. Firms who go to arbitration often do so because their contracts prescribe arbitration; these contracts are the ordinary state-enforceable sort. Because state law casts its shadow on private arbitration (and the disputing firms prefer it), judgments are typically secret. The secrecy of judgments creates problems. Secret judgments increase the incentive for lazy arbitrators to split the difference, rather than search for actual fault. Recently, in order to combat difference-splitting, arbitrators have relied increasingly on American-style procedural rules, which has increased the cost of arbitration and eroded one of the major benefits of private adjudication, its lower cost.

Second, private arbitration firms to my knowledge are not typically prepared to accept disputes between pseudonymous parties. Firms on the internet who seek to avoid state control must use pseudonyms; otherwise states would be able to track them down and interfere with their businesses. It’s imperative that the arbitration firm or court not have access to any concealed real identities of the parties. Otherwise if the identity of the arbitrator is discovered, the government could extract the real identities and prosecute accordingly.

Since a private internet court must attract business without the machinery of the state, most of its rulings would need to be public. It would want to develop a reputation as a truth- and fairness-seeking body. Its opinions would need to be clear, well-reasoned, and principled. Past rulings would serve effectively as advertisements to bring in future business. It could occasionally offer secret proceedings if both parties publicly agreed to be bound by them, but in equilibrium, these would cost more since they could not be used as advertisements.

Since the court could not rely on the state to enforce its rulings, it would need to maintain a publicly accessible database of the compliance of defendants with its rulings. Market participants should be able to query the database with the pseudonym, trade name, or public encryption key of any online business and be able to see immediately whether that entity is out of compliance with the court’s ruling, and if the proceedings were public, the evidence and explanation of the ruling.

To bring a case, a plaintiff would have to pay the court’s fee up front. If the plaintiff won his case, the defendant could be ordered to reimburse the plaintiff for this fee. This ensures that the court always gets paid, and it is the only system I can think of that is fully compatible with the purely voluntary nature of the trial.

What if the defendant declines to participate in the trial? The court cannot force him to participate, but this is less of a problem than it at first seems. The court still has an incentive to supply a fair ruling (which, again, will be publicly verifiable). If it does not, then its database of out-of-compliance defendants becomes worthless. No one will pay attention to a database of people that plaintiffs sued in a corrupt court. For the database to have value, it must at least correlate with fair rulings.

Once one private internet court gets started, it will likely face competition. Courts will compete on fees and reputation for fairness. This will generate a search for efficient rules of civil procedure: what rules of procedure make the optimal tradeoff between cost and information? My intuition is that for the kinds of cases we’re discussing, the rules will need to be very low cost. Since the enforcement mechanism relies entirely on reputation, and firms can always “declare bankruptcy” on their reputation and start over, the cases that will be brought will be relatively small, at least at first. Therefore, the cost of litigation must be low enough to make adjudication worthwhile. I would expect there to be no discovery, which is very costly. In equilibrium, private courts would probably receive a complaint from a plaintiff and a response from the defendant, and then have the opportunity to question both parties. It would then issue a judgment.

While the scenario I have sketched above may seem far-fetched, there are lots of parallels between it and the actual development of merchant law and Anglo-American common law. Early courts in these traditions had little power to enforce their rulings. They also faced competition from other courts, and issued public rulings in order to establish reputations for fairness and efficiency.

If Bitcoin can get past its recent struggles (1, 2, 3, 4), or if some successor medium of exchange is more successful, then demand for state-free adjudication may increase. I’m not ready to abandon my current career plans yet, but given my academic interest in private governance, the internet, and law and economics, I’m willing to hear cases on an ad hoc basis. If you think you’ve been ripped off by a merchant on Silk Road, get in touch. I’m ready to claim universal jurisdiction.

Will the Infovore Utility Explosion Continue?

In the comments on my last post, Indy writes,

Implicit in your analysis is the idea that the welfare explosion for infovores will continue. But what if the phenomenon of the utility explosion of infovores is reaching maturity and coming to an end?

To which I perhaps too hastily replied,

I think that we have not remotely scratched the surface of what is possible in terms of iterating on the internet.

Indy pressed me and I promised a post, so here goes. I’ll give three reasons.

First, there is probably a big difference between the intentional internet and the ambient internet. Right now, for the most part, you decide to use the internet. You sit down at a computer or pull out your smartphone and access whatever resource you have a notion to access. Could it be different? I think probably so. There are push notifications, but I’m thinking beyond that. What if the internet were omnipresent and all useful resources were pushed to you in sort of a just-in-time fashion? Think brain scans + AI + omnipresent internet access. The AI would know more than you do about what resources are available and use your brain scans to determine what you might want to see.

Second, there is a difference between a partial equilibrium response and a general equilibrium response to a price change, and to a large extent we’ve only undergone the partial equilibrium response. The price of using a network for information storage, transmission, and access has gone down, and therefore we’re doing more of it. This is just the law of demand. But the general equilibrium response will consist of rethinking everything to take advantage of this change in price. A weak analogy is the invention of the car: maybe everyone drives more, but it’s not until you have interstate highways that you start to experience all the benefits. What is the thing that we have to rethink to take full advantage of the internet? What would society look like if it were built from the ground up with an internet assumption? I’m not sure, but what I am pretty sure about is that we haven’t fully done the rethinking necessary for complete adaptation.

Third, I see analogies with the invention of cooking. In The Rational Optimist, Matt Ridley writes about how cooking profoundly changed the course of human evolution. Cooking is like having an external stomach; part of your digestion gets done before you consume the food. But things get even more interesting when you realize that Ricardian exchange means that you can have your food digested for you by the person with the comparative advantage in doing so. It is probably this process of trade in digestion that enabled humans to evolve such advanced brains. I wonder if something similar could happen with trade, not just in knowledge (which has been going on for centuries), but in cognition. Future iterations of the internet may be geared toward exactly this, and this change could have profound effects on how we evolve, or for that matter, modify ourselves as a species.

What do you think? Do these ideas make any sense? Are there other reasons to think we’re not nearing the end of the infovore utility explosion?

Net Neutrality: More Complicated Than You Think

On the technology sites I frequent, TechCrunch and Hacker News, there has been an uproar over Google’s joint proposal with Verizon, in which traditional Internet service providers would be subject to net neutrality regulation and wireless providers would not. I think the outrage over Google’s alleged betrayal of Internet users is ill founded. Most of the criticism I’ve seen is not informed by a serious attempt to grapple with economic reality. The real story is much more complicated. It’s so complicated, in fact, that I’m not sure I can make any rigorous statements about net neutrality, but I will try to outline some of the issues.

Let’s start with the most important question: why did Google decide to start being evil? People seem to actually be asking this childish question. The answer, of course, is that good and evil is not a useful framework for analyzing Google’s actions (though if they open concentration camps I will take this back). Google is motivated by profit. It faces incentives. I outlined Google’s strategy for profit-maximization in A Theory of Google. The basic conclusion of that post is that Google benefits from widespread, cheap, and high-quality access to the Internet.

If that’s true, then why doesn’t Google support net neutrality for wireless providers? <sarcasm>It’s almost as though they haven’t given this any thought.</sarcasm> Except that their chief economist is Hal Varian, who is one of the top scholars of the industrial organization of information-intensive markets and coauthor of one of the seminal books of the field, Information Rules. Varian and his fellow Googlers must have some reason to believe that net neutrality could hinder the development of the wireless Internet (though it appears not all of the rank-and-file are on board).

The first step to understanding the economics of net neutrality is to recognize the large fixed costs that accompany any network industry. The presence of large fixed costs means that the simple price-equals-marginal-cost condition for efficiency no longer applies. If all customers were charged MC, the firm would go out of business. It could not cover its large fixed costs. Even if the costs were sunk, the firm would “go out of business” at the margin, refraining from adding capacity on which it would only lose money. In general, large fixed costs imply that price and/or quality discrimination is a necessary feature of an efficient equilibrium (that is, if consumers do not all have identical demand). Read Michael Levine to see how this is the case even in competitive markets!

Another feature of industries with high fixed costs is that they tend to be monopolized or at least highly concentrated. Economists use the term “natural monopoly” to refer to those cases in which the monopolization is due purely to fixed costs and not to any coercive factor. In fact, traditional ISPs, in addition to being natural monopolies, are also coercively monopolized due to municipal franchises that grant them exclusivity. They therefore do not face even potential entry into their markets. A monopolist ISP might favor its own properties on the web, which is what worries net neutrality advocates. But if the monopolist ISP is free to charge whatever prices it wishes for its service, it can’t gain from pushing its own properties, or at least not at the consumer’s expense. Its incentive is to make the Internet as valuable as possible for its consumers so that it can maximize its profits on its monopoly. Remember the logic of double marginalization. If the municipal franchise results in regulated prices, then the monopolist ISP may have a strong reason to favor its own content. It leverages its monopoly position to reap profits through unregulated content rather than regulated Internet service.

A third factor intrinsic to Internet service is congestion. Transferring data on a network reduces the ability of others to do the same. This is a negative externality that can be remedied through a Pigovian tax, or better yet, through a Coasian solution. After all, property rights are well defined and transactions are already occurring. The externality can be resolved by a change in the terms of the contract.

The challenge, then, if you are socially benevolent, is to find a way (1) to efficiently incentivize investment in Internet service infrastructure, (2) to minimize the ill effects of the tendency of the industry to be monopolized, and (3) to reduce congestion, thereby making existing bandwidth capacity maximally valuable. This is not easy. The efficient solution would be something like the following. Consumers would pay for Internet service in two parts. First, they would pay an access fee, which varies from consumer to consumer in proportion to how much they value the Internet. Second, they would pay for the data they consume on a metered basis, with peak rates being higher than off-peak rates to efficiently allocate traffic. There would be no restrictions on the price or quality of service, though violations of service agreements would be prosecuted as fraud. Because the value of Internet service to consumers vastly exceeds the fixed costs associated with running an ISP, my intuition is that all monopolistic municipal charters should be abrogated and all markets contestable.

If that’s the ideal world, it’s not clear whether net neutrality brings us closer to it or further from it. Because we do not observe the ideal pricing structure, net neutrality regulations hamper firms’ ability to ease congestion by de-prioritizing what they believe is the lower-value traffic (remember, if optimal pricing exists, congestion is self-regulating). On the other hand, because some firms are coercive monopolies and face regulated pricing, net neutrality can improve welfare by taking away an inefficient monopoly rent.

Perhaps the most subtle way that net neutrality could be harmful is by aiding collusion between ISPs. If the firms have a sunk investment in infrastructure, regulations that make it more difficult to recover the value of new investments will discourage entry and expansion. Existing firms can carve up the current market and keep prices artificially high.

Google’s position, that traditional ISPs should be regulated and wireless ones should not, is defensible. Competition is more vigorous in the wireless sector than in the wired, and pricing is less regulated. Furthermore, the wireless industry is further from optimal capacity, so we ought to be sensitive to the incentives to invest.

I don’t mean to endorse Google’s proposal; rather, I wish to suggest that critics take the time to learn something about what it is they are criticizing. It’s dismaying to me that so many non-economists think they understand the effects of net neutrality. Skim some of TechCrunch’s recent posts on the topic: they are, frankly, asinine. It reminds me of a quotation from Murray Rothbard:

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

Sovereignty and Statelessness on the Internet

The release of the Afghan War Diary by Wikileaks has drawn a lot of praise and ire. Bizarre examples of the latter include Washington Post columnist Marc Thiessen’s apparent call to classify Wikileaks as a terrorist organization and Rep. Mike Rogers’s demand for the alleged leaker, Bradley Manning, to be executed.

I don’t care too much about the day-to-day politics of the War Diary, but what does interest me is NYU Journalism professor Jay Rosen’s observation that Wikileaks is the world’s first stateless news organization. Wikileaks is of course not literally free of state control; it operates out of Sweden. But the logic of the Internet is that if the Swedish government shuts Wikileaks down, it will move somewhere else. Moreover, Wikileaks is hosted by the same ISP that hosts The Pirate Bay, and they maintain backup servers at undisclosed locations. At least at currently-anticipated levels of government aggressiveness, Wikileaks can publish what it wants with impunity.

The Internet has elements of anarchy. Yet many businesses do not take advantage of the freedom the Internet affords. They choose, instead, to be subject to state law. This was initially puzzling to me. Why don’t all Internet businesses operate like Wikileaks, avoiding regulation and taxes imposed upon them by the state?

The answer, at least in part, is that some companies benefit from the credible commitment that an external enforcer enables them to make. Thomas Schelling makes this point:

Among the legal privileges of corporations…are the right to sue and the “right” to be sued. Who wants to be sued! But the right to be sued is the power to make a promise…a prerequisite to doing business.

Diego Gambetta, in his book on the Sicilian Mafia, also recognizes the value of buying protection against oneself.

This is why companies like PayPal (and its parent company eBay) don’t follow the Wikileaks strategy. Instead they happily make their headquarters and host their servers in the United States. If they get sued and lose the case, the US government will force them to pay up. And for the privilege of being forced to pay up, they abide by US regulations and pay significant sums in taxes. The ability to successfully sue PayPal is why so many of us fork over our bank account details to PayPal.

It’s tempting to think that as the Internet matures, governments will become increasingly irrelevant. Perhaps they still will. There are other mechanisms that can be used or discovered to credibly commit to honest dealing. Since information is transmitted rapidly and at low cost over the Internet, reputation mechanisms are appealing. But it is unlikely that governments will go away completely, even on the Internet. As long as some firms find government’s enforcement role to be worth the regulatory and tax burden, the virtual world will be tied to the territorial one.

Even if some companies choose to remain subject to government law, we can all benefit from the increased ability to opt out of the law, as Wikileaks has effectively done. If the cost of opting out fell to zero, Internet firms would bear the regulatory and tax burden only if the benefits of enforcement exceeded those costs. This would yield not only greater freedom of expression, but greater economic and personal freedom. To the extent that the Internet can be reengineered to be more decentralized, self-healing, encrypted, reputation-based, and so on, we can limit the pernicious effects of unwanted government involvement in commerce and communication.