The Economic Case for Public Subsidy of the Internet

The paper attempts to apply a broad range of economic concepts to the Internet. Externalities associated with the net are defined and some attempt is made to measure them. The affect of the market power (oligopoly power) of some of the producers and consumers in the Internet "industry" is given a preliminary analysis. Findings of a field called information economics, which deals with the special economic characteristics of information as a good, are summarized. Questions pertaining to the effect of potential economies of scale in production, possible high levels of required investment (so- called "indivisibilities in investment"), interdependence in production and consumption, and other factors are examined. When these characteristics appear in an industry they cause the market system to be an inefficient producer of a good. If the market system cannot adequately supply a good, in economic jargon, that is called "market failure". The contention of my paper is that the Internet represents a massive case of market failure, and that network services on a large scale can never be produced adequately through the private market mechanism. In fact, the Internet is a special type of good called a "quasi-public good", which means that network services can be produced to a limited extent by the private market acting without government intervention, but an efficient market cannot exist. The electric power industry, the highway system, the education system, and the health care system are examples of quasi- public goods. They can be produced to a limited extent through the private market, but a functioning modern society requires that they be more widely available than the private sector can provide. Decisions about funding and control of quasi-public goods invariably cause profound controversy in our economic system. One economic characteristic of the Internet which is touched on in my paper and has seemed to arouse special interest among networkers is the discussion of transactions costs. When transactions costs are large, economic theory says that market failure will inevitably occur. One important type of transaction cost associated with the network is the cost of enforcing property rights. Private markets can only be established for goods for which property rights can be guaranteed and are easily exchangeable. Numerous other economic factors which impact on the production of network services are analyzed. The conclusion of the paper is as follows: The application of price theory (modern economic theory) to the Internet leads to the conclusion that market prices cannot by themselves efficiently allocate resources for the production and use of network services.