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All in the game – how the game theory framework helps design and understand leniency laws

ShreedharSasikumarMost game theory discussions start with an explanation of the “prisoners dilemma”. If only for the sake of originality (and since we will be coming back to the prisoner’s problems), let us start with a different ‘game’, the “driver’s dilemma”.

Imagine a world with no traffic rules. A driver can choose to drive on either the left or the right side of the road. Now, think of two drivers approaching a bend in the road from opposite directions. Since the road is curved, neither can see which side of the road the other is on. If both of them are on the same side of the road, they will crash into each other. If they are on opposite sides, they will pass each other with no incident. The following table shows the potential payoffs in this interaction.

Driver’s dilemma – No traffic rules

Driver's dilemma - No traffic rules

In a world with no rules, there is a 50 per cent chance that a driver will drive on the right and an equal chance that he or she will drive on the left. Since the individual driver cannot know the other driver’s choice, there is now a 50 per cent chance that they will both chose the same side and a 50 per cent chance that they won’t. And this means a 50 per cent chance of a crash each time they round a corner.

But if there were a law that fined drivers USD 500 for driving on the right, then all rational drivers would chose to drive on their left, thereby avoiding crashes.

Achieving beneficial outcomes for the group by aligning individual incentives

Game theory shows that a collection of individuals often act rationally and yet end up with outcomes that are bad both for the individual and for the group. In these situations, laws can be used to align individual incentives, for instance, let everyone agree on a side to drive on. This in turn leads to outcomes that are beneficial to the individual and to the society. Game theory frameworks can be used to identify areas where laws are necessary. Indeed, game theory justifies the very existence of laws in a free society!

Laws are designed to help individuals interact with each other productively to create successful societies and game theory is the study of how individual interactions add up to group outcomes. Game theory frameworks therefore, can be applied to a variety of legal questions.

For example in tort law, game theory can assist lawmakers and judges in setting punitive damages for defective products so as to incentivise manufacturers to establish the correct quality procedures. Game theory is also useful in intellectual property cases where regulators must balance the need to reward innovation (patent protection) against the necessity to make the innovation widely available (allowing generics). However, the most commonly discussed application of game theory in legal questions is the use of game theory in leniency policies, especially in the realm of antitrust enforcement.

Busting cartels and conspiracies using leniency

Broadly speaking, a leniency policy is an agreement that a member(s) of the conspiracy who assists law enforcement in proving a conspiracy will be given a reduced punishment, or perhaps no punishment at all.

When law enforcement investigates a crime, they usually suffer from an information asymmetry, that is, the conspirators know more than the enforcers about how the crime was committed. If the conspirators co-operate, then it becomes very difficult for law enforcement to obtain the proof they need to prove the conspiracy. By offering reduced punishments, leniency systems can give individual conspirators an incentive to ‘betray’ the conspiracy. This in turn provides enforcers with the necessary information to prove the conspiracy and punish the participants.

To illustrate how a leniency system can be an effective tool for law enforcement, let us use that canonical example of game theory, the “prisoner’s dilemma”.

First, consider a system without a leniency policy. Two criminal accomplices (A and B) have conspired in a serious crime that carries ten years in prison. The police however, have evidence of only a minor crime punishable by only two years in prison. The police need information from at least one of them to have proof of the serious crime. The table below describes each person’s payoffs in this scenario.

Prisoner’s dilemma – no leniency

PrisonersDilemma_NoLeniency1

In this scenario, both A and B will clearly stay silent. In any scenario other than both staying silent, they both get 10 years in prison. So without a leniency policy, neither will co-operate and law enforcement is unable to prove the major crime.

Now, what if the police were to offer some ‘leniency’ for cooperation. Both criminals will be offered a chance to confess. If one confesses while the other stays silent, the confessor will go free while the non-cooperator will get the maximum 10 years. However if both co-operate, both can get a reduced sentence of 6 years. The table below describes the payoffs in the revised scenario.

Prisoner’s dilemma – with leniency

PrisonersDilemma_WithLeniency1

In the revised scenario, if B is going to be silent, A is better off talking because A would go free. If B is going to talk, A is again better off talking since a six-year sentence is better than a 10-year sentence. So whatever B does, it is better for A to talk, so as a rational person, A will talk. However, if B is equally rational, he will talk as well. With both confessing, law enforcement can convict both for the serious crime.

This shows that leniency policies can be a powerful tool for law enforcement to break criminal conspiracies like cartels. For one, they provide the possibility of detecting conspiracies that might have gone undiscovered. Secondly information gleaned through the leniency system make it much more likely that the conspiracy can be proven and the participants sanctioned.

Perhaps more importantly, leniency policies act as a deterrent for conspiracies. If each conspirator knows that their partner has an incentive to betray them in the future, they are less likely to enter into the conspiracy to begin with. This is especially true when leniency is offered only to the first conspirator to come forward, creating a potential ‘race to betrayal’. Promoting confusion and mistrust in a conspiracy through leniency policies makes it less likely that a conspiracy can form or continue for long periods.

Leniency systems however, are no magic bullet. A leniency policy without a strong enforcement and investigative program for example, is toothless. Unless one or more conspirators fear imminent detection, they will have no incentive to come forward. Similarly, the level of punishment and leniency matter. If sanctions for conviction are minor, then it reduces the value of the leniency in coming forward.

Too much leniency however, means reducing the deterrent for forming conspiracies in the first place. At times, leniency policies can provide incentives for false testimony or even encourage the formation of cartels in certain situations. The specifics are important and game theory frameworks can be very useful in calibrating leniency policies. The dynamics of how game theory is used in setting the optimal policies for different situations is a fascinating discussion in itself. But to quote the famous Kipling, ‘that is another story for another time’.

Law enforcement uses leniency systems in a variety of contexts. The most common version is similar to the “prisoner’s dilemma” and a staple of most cop TV shows, where investigators urge a criminal ‘to roll’ on his accomplices. Whistleblower laws that reward employees for reporting malfeasance by their employers is another form of leniency policy. Perhaps the most discussed application of leniency policies is in investigating cartels of companies indulging in anti-competitive activities like price-rigging. Cartels are often very difficult to prove because much of the collusion between the firms is tacit and undocumented. This makes it crucial to have ‘inside info’ from one of the participants. A famous recent example was when Samsung was granted immunity by the European Commission for revealing a conspiracy with other firms like LG to collude on the prices of LCD screens. However, while it is a powerful tool, it must be used judiciously because there is much potential for abuse or for creating an environment where law enforcement seems inconsistent and arbitrary.

(Shree is a wandering economist who has changed his address fourteen times in the last fourteen years. He has few ideas except those opposite to who he is talking to.)

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Four rules that will help you navigate the perils of online legal research

DeekshaSinghAs online resources become the primary tool for legal research, some basic rules will help avoid common pitfalls.

1. Have a research plan

We have all gone online to look up one thing and ended up some time later reading or watching something completely unrelated. It is easy to lose track of where you are up to and even what things you have already looked at.

To deal with this, you could maintain handwritten notes or keep notes on a separate document open on your computer. List the websites that you have been to and keep track of the sources you want to come back to. Many subscription services, such as Manupatra, even provide a function where you can save all or some of your search results.

Also remember that when you use search engines like Google, Yahoo!, and the like to find resources, you need to follow a research plan. If you do not know what you are looking for, then a general Internet search is probably going to result in you wasting more time, rather than finding anything useful. In those cases, it’s better to start with a general text or other treatise on the subject. However, if you do know what you are looking for—a specific case or author, for example—then you may find online, exactly what you need, very quickly.

A note of caution here—if you are presenting a research paper in law school, for example, do not simply rely on the contents of what comes up in the first one or two pages of a Google search. If you do, you will likely find that your research is no more extensive (and almost identical) to that of many other students in your class.

2. Identify the correct search terms

One of the key steps of legal research, whether online or offline, is generating the right search terms.

Keep a note of key words that come to mind as you are analysing the legal problem. It is easier to generate key search terms by keeping in mind categories of information such as the parties, the places and things involved in the case, the potential claims or cross-claims and defences, the conduct of the parties, and the injury or harm suffered.

JuvenileJusticeWordCloudIt helps to start with broad search terms and to narrow them down as your research proceeds, especially if you are researching an issue in an unfamiliar area of law. You can narrow the search terms down once you are sure you are on the right path. Looking at the results from broad search terms and reconsidering the research issue before you, will help you generate narrower search terms.

Remember, in online research, you may have to play around with several search terms to ensure that you are aiming your research in the right direction. Starting with a simple one-word Google search is most likely going to be useless, or at least a waste of time.

The increased use of technology has also changed the legal research landscape in many ways. We now have access to a wider variety of authorities, both within and from outside any jurisdiction. This makes the analysis of information and critical thinking about the law even more difficult and we need to be able to do more than enter queries into search engines. We need to be able to access, sort, and analyse information intelligently and in a continuously flexible fashion.

It might actually be more helpful to begin with a general textbook or other print resource if you are doing research in an area that you are unfamiliar with. Something as simple as scanning a table of contents might help you frame a more effective search term, find the leading case or main statute, or help you narrow down the areas you need to look into further.

3. Know when your research is sufficient

When do you know that you have done enough research? Efficient research requires knowing not only how and where to begin research, but also having an idea of where to draw the line in the research process. No matter what form of research you are doing, you will need to learn to recognise when to stop your research and collate it.

The challenge with legal research these days is to find the information that you need from amongst the massive amount of information available online. Any search that you conduct turns up hundreds, or thousands, of results. Often two practical considerations will limit your research: namely economics (or the costs involved), and the time you have to complete your research.

When you are given a topic to research at work, it is important to evaluate the stakes that are involved. If it is a legal opinion for a client, then you need to decide beforehand, the amount of information your client would require at that stage. If your firm is billing the client by the hour, the research can be endless but time is an important factor that will dictate the conclusion of your research.

Apart from these practical considerations, the findings of your research may by themselves indicate when you need to stop. It is highly unlikely, for example, that you will find a case with facts identical to your case, but if you have found a case with similar legal issues, and from a superior court in your jurisdiction, in short, a case that is ‘on point’, then you can probably safely end your research on that issue. Another indication that your research is complete is when you begin bumping into the same authority repeatedly.

4. Ensure the information you find is credible and accurate

One of the biggest challenges in online research is ensuring the credibility of your sources and the accuracy of the information you get.

librarycardstackIn the case of primary sources, for example, you might wonder how you know whether the legislation that you are reading is the most up-to-date version. The variety of secondary sources presents even greater difficulties. You might find an article but how do you know whether the person who has written it is credible, or has sufficient knowledge in the area so as to be reliable?

Often, you will not be able to confirm the veracity of your sources but you can, however, ensure that you choose more popular sites more often, and rely on those sites, services, and authors that are generally considered credible. Use your common sense—it might be okay to present a blog post as evidence of someone’s opinion, but unless the author is an established expert in the field, it is probably not a good idea to rely on that opinion as truth or authority, or as a way of establishing something as a fact.

Most departments of the government and government bodies such as courts and regulatory bodies have websites. While some are better than others, many of them contain a wealth of information. Legislation and the judgments from most superior courts in India are available online. The versions of judgments and statutes that you find on these websites are usually reliable as they are published by the very body that produced or authored them. When conducting research on areas of international law, take the time to find the official government websites.

A note of caution here—unfortunately in India, government websites are often not updated to reflect the most current statute. You will often find old versions. Always combine your research on government websites with research on paid subscription resources or even a recent printed text to be sure that you are relying on current legislation.

Databases hosted by universities and other higher learning institutions are often excellent sources for authoritative journal articles.

Then, there are unofficial websites that focus on law and legal research. By ‘unofficial’, we mean those that are not hosted by a recognised governmental department or established university. Just keep in mind that you may need to back up or check your research with a more credible source, or with a print resource, depending on what you are researching and the kind of audience your research will be presented to. Some free, popular and useful websites for Indian law resources on the Internet are JUDIS, Google Scholar, and IndianKanoon.

In addition, there are subscription databases that you will only have access to if you, your firm, university, or company has a paid subscription. These databases, such as Manupatra, LexisNexis, and Westlaw, include judgments and legislation, and many also offer a significant database of scholarly articles and textbook-style material. Each of these databases is presented and used differently, so you do need to ensure that you learn how to use them properly to research efficiently and effectively.

To conclude, as with most aspects of legal research, online research takes practice and some patience. We should not make the mistake of thinking that, because we are all so familiar with the Internet these days and use it constantly, that online legal research will be similarly easy or familiar. Take some time to learn about the different resources that are available, and familiarise yourself with the various search techniques that you need to use across those resources. As you develop your research skills, you will become familiar with the sites that you consider most reliable and simple to use. By relying on those sites and databases that you trust, as well as constantly being on the look out for new resources, you will always have the information that you need at your fingertips.

Deeksha Singh is part of the faculty at myLaw.net.

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Best efforts clauses: Reluctance of US courts to define a “best effort” shows it is important to define it in the contract

SamarJha“Best efforts” clauses are among the most contentious and heavily negotiated clauses in asset purchase and share purchase agreements. They require one (or both) of the parties to use their highest efforts to perform some obligation. While the clause may (or may not) require a party to achieve a specific goal, the use of the term “best efforts” creates a strict standard of compliance. Effort clauses therefore require a party to commit to a particular standard of effort to comply with the provisions of the contract. For instance, in the clause, “Supplier agrees to use commercially reasonable best efforts to satisfy the requirements of…”, the best efforts clause is qualified with the term “commercially reasonable”. Common variations of “best efforts” include “reasonable efforts” and “commercially reasonable efforts”.

These clauses are generally used in situations where a party cannot guarantee a particular outcome that has to be performed under a contract, where a situation is beyond a party’s control, where there is unpredictability about the promising party’s ability to achieve an objective, or where a promising party refuses to agree on a covenant. For example, a clause may specifically state, “The Purchaser shall make any necessary filings with respect to, and use its [best efforts/reasonable best efforts/commercially reasonable efforts] promptly to obtain, all authorizations, consents, orders and approvals of all Governmental Authorities and officials that may be or become necessary for its execution and delivery of, and the performance of its obligations pursuant to, this Agreement and will cooperate fully with the other parties in promptly seeking to obtain all such authorizations, consents, orders and approvals.”

According to § 2-306 (2) of the Uniform Commercial Code (“UCC”), a lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes, unless otherwise agreed, an obligation on the seller to use “best efforts” to supply the goods, and on the buyer to use “best efforts” to promote their sale.

The UCC standards are unclear because Official Comment 5 does not distinguish between “best” and “reasonable” standards of effort. It explains that the obligation on the parties is to use “reasonable diligence as well as good faith”. On the face of it, it looks as if the standard is not that strict.

Your reasonable efforts are your best efforts, say US courts

BestEffort

 

Interpreting such terms according to the facts and circumstances of the case, courts have interpreted “best efforts” as “reasonable efforts” and in decisions such as Soroof Trading Development Company LTD. v. GE Fuel Cell Systems LLC, 842 F. Supp. 2d 502 (S.D.N.Y., 2012) by the Southern District of New York, these terms have even been used interchangeably. In Bloor v. Falstaff [601 F.2d 609 (2d Cir. 1979)], the court stated that while performing its obligations using best efforts does not necessarily “prevent the party from giving reasonable consideration to its own interest”, such action or inaction has to be in “good faith and to the extent of its own total capabilities” and like an “average prudent” performer. In US Airways Group, Inc. v. British Airways PLC [989 F. Supp. 482 (S.D.N.Y. 1997)], British Airways delayed investments totaling USD 750 million into the US Airways Group by not obtaining the necessary approvals without telling the latter about their intentions to not continue with the deal. The duty of good faith and fair dealing, the court said, is implied in every contract and the actions of British Airways were construed as not being their “reasonable best efforts” and a transaction done in ba

In Hexion Speciality Chem. Inc. v. Huntsman Corp. [965 A.2d 715 (Del. Ch. 2008)], the court held that the buyer breached its covenant to use “reasonable best efforts” to close the merger (Huntsman was the target, and Hexion the buyer) when Hexion took steps to subvert the financing it was seeking to acquire Huntsman. Hexion filed a suit seeking to terminate the merger without paying the contractually mandated reverse break-up fee. It argued that the surviving entity after the merger would be insolvent and Huntsman’s poor financial results triggered the material adverse effect clause in the agreement. It was held however, that one poor financial result does not trigger it and that ultimately, since Hexion did not perform the obligation in good faith, its actions constituted a willful and intentional breach.

Recently, in Apollo Tires v. Cooper Tires, Civil Action No. 8980-VCG, the moot point was whether Apollo Tires (the buyer) had failed to use “reasonable best efforts” to reach the negotiated agreement with the United Steelworkers Union (“USW”) as required by the merger agreement. The court said that a provision that specifically mandated an obligation to obtain antitrust and other regulatory approvals couldn’t be interpreted to include within it, an obligation to obtain third-party contractual consents. The language of the efforts clause asked for obtaining antitrust and other regulatory approvals and did not talk about third-party consents. In the end, Cooper Tires could not prove that Apollo Tires did not use “reasonable best efforts” to obtain the consent from USW.

Courts clearly are reluctant to provide a definition for “best efforts”. They rightly treat this issue according to the specific facts and circumstances of the case and do not have a particular definition for the term. It is not a “hell or high water” clause as it is sometimes called because, as we have seen, the promising party does not always have to do everything in its power to conclude the obligation. The courts make sure that the promising party does not ignore their own interest, incur losses just to perform the obligation, or ignore its fiduciary duties. It is important however, that the promising party’s obligation is performed in good faith and there is no willful breach of the obligation.

Define “best efforts” to reduce uncertainty

To avoid uncertainty in terms of performing obligations and enforcement, firstly, it is important for the parties understand their rights and obligations under the “best efforts” provisions. Parties can also define the terms in the contract. As we have seen, courts have provided a subjective interpretation only when the agreement did not provide a definition for “best efforts”. The definition should clearly define the promisor’s capability, reasonable business practice, and the industry standard in relation to the obligation. Providing objective criteria would implore the courts to stick to the contractual language.

Samar Jha recently received an LLM from the University of Pennsylvania Law School.

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After Satyam – how a scandal changed corporate governance law in India

VeraShrivastavThe Satyam scandal of 2009 gave Indian corporate stakeholders a cataclysmic jolt. Ramalinga Raju, who was recently sentenced to seven years in jail, was the chairman of Satyam Computer Services who committed financial fraud to the tune of Rs. 7000 crore. Shockingly, the company’s auditors, PricewaterhouseCoopers, did not notice it. The scale of the scandal and the auditing firm’s neglect brought to light glaring loopholes in the regulatory and legal framework dealing with the directors and the auditors of companies. Eventually, it led to changes in the law.

Before Satyam

Before the scandal, the erstwhile Companies Act, 1956, the primary legislation dealing with the conduct of corporations in India, did not contain any provision for independent directors or impose any stringent obligations on auditors. The report of the Kumar Manglam Birla Committee in 1999 recommended improvements to the function and structure of the board of directors of a company and emphasised disclosures to shareholders. Clause 49 of SEBI’s Listing Agreement (applicable to listed companies only) became a reflection of these recommendations. In 2002, the Naresh Chandra Committee on corporate audit and governance, drawing from the Sarbanes-Oxley Act in the United States, suggested various reforms relating to the appointment of auditors, audit fee, and the certification of accounts. In 2003, the Narayana Murthy committee analysed the role of independent directors, related parties, and financial disclosures. Clause 49 was amended to incorporate its recommendations with respect to the requirement of independent directors on corporate boards and audit committees and the compulsory disclosures that listed companies had to make to its shareholders.

After Satyam

After the scandal, the Confederation of Indian Industries set up a task force to suggest reforms and the National Association of Software and Services Companies established a corporate governance and ethics committee headed by Narayana Murthy. The report of the latter addressed reforms relating to audit committees, shareholder rights, and whistleblower policy. SEBI’s committee on
disclosure and accounting standards issued a discussion paper in 2009 to deliberate on (i) the voluntary adoption of international financial reporting standards; (ii) the appointment of chief financial officers by audit committees based on qualifications, experience, and background; and (iii) the rotation of auditors every five years so that familiarity does not lead to corporate malpractice and mismanagement. In 2010, SEBI amended the Listing Agreement to include the provision dealing with the appointment of a chief financial officer but it did not insist on the compulsory rotation of auditors.

In 2009, the Ministry of Corporate Affairs also released a set of voluntary guidelines for corporate governance, dealing with the independence of directors, the roles and responsibilities of audit committees and the boards of companies, whistleblower policies, the separation of the offices of the chairman and the CEO to ensure independence and a system of checks and balances, and various other provisions relating to directors such as their tenures, remuneration, evaluation, the issuance of a formal letter of appointment, and placing limits on the number of companies in which an individual can be a director.


March2015 APCCLP banner

A new company law – independent directors, accountable auditors, additional disclosures

India’s 2013 company law incorporated many provisions and reforms suggested by the various committees and organisations during the past decade. It clearly established the responsibility and accountability of independent directors and auditors. It provided for the compulsory rotation of auditors and audit firms. In fact, it even prescribed a statutory cooling off period of five years following one term as an auditor.

Under the Companies Act, 2013 (“the Act”), an auditor cannot perform non-audit services for the company and its holding and subsidiary companies. This provision seeks to ensure that there is no conflict of interest, which is likely to arise if an auditor performs several diverse functions for the same company such as accounting and investment consultancy services. Auditors also have the duty to report fraudulent acts noticed by them during the performance of their duties.

Ramalinga Raju

Ramalinga Raju

The new law also insisted on companies having independent directors, that is, directors who do not have a material or pecuniary relationship with a company. The requirement under Clause 49 of the Listing Agreement, which applied only to listed companies, would thus apply to many more companies. Independent directors have been prohibited from receiving stock options and are not entitled to receive remuneration for their services, except for reimbursement. At least one-third of the board of a company has to consist of independent directors. Even the audit committee has to feature a majority of independent directors. One independent director is required to be a member of the remuneration committee as well.

Additional disclosure norms such as the formal evaluation of the performance of the board of directors, filing returns with the Registrar of Companies with respect to any change in the shareholding positions of promoters and the top ten shareholders, were also mandated. After Satyam, aggrieved Satyam stakeholders in the United States were able to initiate class action suits against the company and its auditors for damages. The same remedy is now available to Indian stakeholders.

(Vera Shrivastav is an Associate at LegaLogic law firm and is a part time researcher and writer.)

 

 

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A neutral Internet may not be the best idea for India

ShreedharSasikumarMost consultation papers go straight from the printer to the archives but the latest from India’s telecommunications regulator, the TRAI, on a regulatory framework for over the top (“OTT”) services, has prompted strong dissent.

Let us get this out of the way early. The paper is a terrible piece of public policy. It reads as if written by a lobbyist for Airtel and the synopsis could well be, “Internet publishers like Google and Facebook are making a boatload of money using our (Telecom Service Providers) networks and we want a bigger cut”.

Most of the ‘angst’ expressed by telecom service providers (“TSPs”) is directed at messaging services (like Whatsapp) and Voip services (like Skype), which are ‘free-riding’ on TSP networks. These OTT services provide customers an alternative to TSP services like SMS and international calls. Since OTT services are exempt from the various quality and consumer protection regulations placed on TSPs, the paper argues that OTT services deprive ‘licensed operators and governments of their legitimate revenues’. The paper then continues on to twist itself in loops to expand the definition of OTT services to services offered by YouTube, Facebook and Flipkart, that is, pretty much any service on the Internet that makes any money (TSPs cant really charge messaging and Voip services because they have infinitesimal revenue). The paper ‘asks’ whether OTTs should be regulated and if there is ‘a justification for charging differential prices for data access’.

top_bannerAnd it is this point on ‘differential pricing’ that has attracted the ire of advocates who warn that if TSPs are allowed to charge publishers, TSPs and deep-pocketed publishers (but not consumers) will decide what Internet services the public will access. To their opponents, zero-rating plans like Internet.org and Airtel Zero presage a fragmentation of the Internet in to gated playgrounds, in short, the death of the open and free Internet.

‘What is ‘Net Neutrality’?

‘Net neutrality’ might be (simplistically) summarised as the principle that the ISPs have to treat all data on the Internet equally. Customers pay ISPs for unrestricted access to all the data on the Internet. So ISPs should not be able to make agreements to favour one Internet service or the other.

Under net-neutrality principles, Airtel cannot allow the Indian Express to pay to have its webpage load faster than that of the Times of India. Nor can Vodafone charge data fees for videos watched on Hulu while foregoing data charges for YouTube users. Net-neutrality principles create a ‘firewall’ between the creators of Internet content and the middlemen, the ISPs. Customers remain the sole arbiter of which Internet website or service or app they want to access.

Why publishers are not entirely sure about a neutral Internet

Large Internet publishers like Google, Amazon, and Facebook are usually supportive of net-neutrality principles. They want to avoid having to pay ISPs to reach Internet users and they want to prevent their products from being blocked by an ISP, while the ISP offers a competing service of its own. Google’s struggles in launching Google Wallet even as telecom companies were working on their competing product, Softcard, illustrate this.

However net-neutrality is not always in the interest of established or deep-pocketed publishers. On the Internet, the kid in a garage can (in theory) compete with Google as long as he has a better algorithm, the last true meritocracy. However in a world without net-neutrality, Google could pay ISPs to make sure their pages load quicker through a dedicated line, leaving the garage genius’s algorithmic brilliance defenceless against Google’s cheque-book. Why would any Reliance user now try a new social network like Ello, for which they have to incur data charges to use, unlike Facebook, which is free to access on Reliance’s network?

If ISPs can make direct arrangements with publishers for favorable access, it creates a ‘pay to play’ system. In such a world, the successful Internet services will be the ones that pay the ISPs the most, not the ones that create the most customer value. ’Net-neutrality’ therefore, is central to keeping the Internet a level playing field.

What neutrality without the Internet?

In the developing world however, the primary challenge for Internet publishers is the fact that users are not connected to the Internet. Most of Africa seems to have Internet penetration rates of less than 10 per cent of the population. Less than 20 per cent of the Indian population is connected to the Internet.

Construction_worker_cellphone

The unconnected represent a veritable ocean of potential ad-clicks and e-commerce, giving Internet companies a powerful incentive to assist in getting the world online. This is especially true of Google and Facebook whose revenues on any given day are essentially a function of how many people are online to see ads. This is to some extent the motivation behind initiatives like Internet.org or Android zero-rating. Amazon, Flipkart, Uber, India Today, and really any publisher whose profit-per-user is higher than the data costs, has an incentive to participate in programs like ‘zero-rating’, that subsidise a customer’s Internet use. In turn, guaranteed payments from publishers give TSPs and ISPs a strong incentive to build network capacity in underserved rural areas rather than run risk of their expansions going unused because subscriber incomes are too low to afford Internet services. So if Facebook wants to pay your Internet bill, why not let them?

Because, unless you believe that Internet publishers are altruists, Pandora is not going to pay for streaming Spotify, nor is Ola going to support the use of Uber. ‘Zero-rating’ will create Internet corners where only a subset of services are available. This means a fragmented Internet and a steep uphill slope for new Internet publishers. Any consumer benefit from ‘free’ data could also be short-lived. Over the long-term, publishers might pass the data costs back to consumers, either though more ads or higher usage fees for the Internet service.

But what is the point of a ‘neutral net’ if 80 per cent of the public cannot get online? Bing might be a terrible search engine, but it is still better than the offline alternative of the local library. An Internet restricted to publishers who can subsidise data costs might be better than no Internet at all.

Safety in nuance

Net-neutrality (like most public policy) does not need to be a ‘one size fits all’ policy. Countries like South Korea (or the US) where a high proportion of the population is connected can afford a strong net neutrality regime since access is not a constraint. Countries like India might want to prioritise investments in access over competitiveness and progressively adjust their net neutrality regulations over time as greater proportions of the population come online and can afford their own Internet access.

ethernet-cableNet-neutrality could also be rendered ‘moot’ in markets where there is a high level of competition between local ISPs or TSPs. If consumers have their choice of ISP, they will punish any attempts to restrict access to their favorite websites by switching providers. Unfortunately, the high fixed investments mean that there are very few markets have more than two or three viable ISPs.

All net-neutrality laws are not created equal. We can almost universally agree that ISPs should never be allowed to restrict consumer choice by blocking content. But ‘blanket-bans’ on any publisher-ISP relationship is not necessary. An example of compromise between access and competition might be to cap the amount of data that can be zero-rated, that is, say a company can at most subsidise 100 MB of data to ensure the subsidies mostly flow to those who could not afford the data otherwise. In the net-neutrality debate, it is the details that will make the difference between throttling or freeing the Internet.

Regulations that prevent differential pricing but are silent on whether ISPs can charge for direct connections and other types of preferential access would be worse than useless. Such a situation would allow preferential access to powerful publishers without even the benefit of subsidies to consumers as in zero-rating plans. One could argue that this is the situation the US finds itself in despite being considered a ‘net neutral’ country. Netflix already pays ISPs for direct access to their network. Google sends hard-disks with popular YouTube videos to ISPs so that they be cached and delivered faster than any other video service. Even the newly proposed FCC regulations are largely silent on the matter of ‘inter-connection’ fees, leaving open the prospect for ISPs to price discriminate by charging for ‘direct access’ to their networks. The specific implementation of net-neutrality matters.

iLaw_InternationalCoursesNet-neutrality questions have engendered passionate discussion across continents these past two years. The dimensions of the question are far more complex than a single article like this can encompass. For example, we have spoken little about inter-connection fees between ISPs, publishers becoming ISPs, or governments restricting content and these questions might be even more crucial to Internet openness than differential data pricing.

Given these complexities, applications of net-neutrality principles must be tailored to the context. Knee-jerk support, both for and against, is terrible public policy. The truth in public policy is that the right answers depend on calibrating any regulations to the needs of the given context and time.

(Shree is a wandering economist who has changed his address fourteen times in the last fourteen years. At one of those addresses, he worked for Google. He has few ideas except those opposite to who he is talking to.)