a review of Michael Kende, The Flip Side of Free: Understanding the Economics of the Internet (MIT Press, 2021)
by Richard Hill
This book is a must-read for anyone who wishes to engage in meaningful discussions of Internet governance, which will increasingly involve economic issues (17-20). It explains clearly why we don’t have to pay in money for services that are obviously expensive to provide. Indeed, as we all know, we get lots of so-called free services on the Internet: search facilities, social networks, e-mail, etc. But, as the old saying goes “there ain’t no such thing as a free lunch.” It costs money to provide all those Internet services (10), and somebody has to pay for them somehow. In fact, users pay for them, by allowing (often unwittingly: 4, 75, 92, 104, 105) the providers to collect personal data which is then aggregated and used to sell other services (in particular advertising, 69) at a large profit. The book correctly notes that there are both advantages (79) and disadvantages (Chapters 5-8) to the current regime of surveillance capitalism. Had I written a book on the topic, I would have been more critical and would have preferred a subtitle such as “The Triumph of Market Failures in Neo-Liberal Regimes.”
Michael Kende is a Senior Fellow and Visiting Lecturer at the Graduate Institute of International and Development Studies, Geneva, a Senior Adviser at Analysis Mason, a Digital Development Specialist at the World Bank Group, and former Chief Economist of the Internet Society. He has worked as an academic economist at INSEAD as a US regulator at the Federal Communications Commission. In this clearly written and well researched book, he explains, in laymen’s terms, the seeming paradox of “free” services that nevertheless yield big profits.
The secret is to exploit the monetary value of something that had some, but not much, value until a bit over twenty years ago: data (63). The value of data is now so large that the companies that exploit it are the most valuable companies in the world, worth more than old giants such as producers of automobiles or petroleum. In fact data is so central to today’s economy that, as the author puts it (143): “It is possible that a new metric is needed to measure market power, especially when services are offered for free. Where normally a profitable increase in price was a strong metric, the new metric may be the ability to profitably gather data – and monetize it through advertising – without losing market share.” To my knowledge, this is an original idea, and it should be taken seriously by anyone interested in the future evolution of, not just the Internet, but society in general (for the importance of data, see for example the annex of this paper, and also here).
The core value of this book lies in Chapters 5 through 10, which provide economic explanations – in easy-to-understand lay language – of the current state of affairs. They cover the essential elements: the importance of data, and why a few companies have dominant positions. Readers looking for somewhat more technical economic explanations may consider reading this handbook and readers looking for the history of the geo-economic policies that resulted in the current state of affairs can read the books reviewed here and here.
Chapter 5 of the book explains why most of us trade off the privacy of our data in exchange for “free” services: the benefits may outweigh the risks (88), we may underestimate the risks (89), and we may not actually know the risks (91, 92, 105). As the author correctly notes (99-105), there likely are market failures that should be corrected by government action, such as data privacy laws. The author mentions the European Union GDPR (100); I think that it is also worth mentioning the less known, but more widely adopted, Council of Europe Convention (108). And I would have preferred an even more robust criticism of jurisdictions that allow data brokers to operate secretively (104).
Chapter 6 explains how market failures have resulted in inadequate security in today’s Internet. In particular users cannot know if a product has an adequate level of security (information asymmetry) and one user’s lack of security may not affect him or her, but may affect others (negative externalities). As the author says, there is a need to develop security standards (e.g. devices should not ship with default administrator passwords) and to impose liability for companies that market insecure products (120, 186).
Chapter 7 explains well the economic concepts of economies of scale and network effect (see also 23), how they apply to the Internet, and why (122-129) they facilitated the emergence of the current dominant platforms (such as Amazon, Facebook, Google, and their Chinese equivalents). This results in a winner-takes-all situation: the best company becomes the only significant player (133-137). At present, competition policy (140-142) has not dealt with this issue satisfactorily and innovative approaches that recognize the central role and value of data may be needed. I would have appreciated an economic discussion of how much (or at least some) of the gig economy is not based on actual innovation (122), but on violating labor laws or housing and consumer protection laws. I would also have expected a more extensive discussion of two-sided markets (135): while the topic is technical, I believe that the author has the skills to explain it clearly for laypeople. It is a pity that the author didn’t explore, at least briefly, the economic issues relating to the lack of standardization, and interoperability, of key widely used services, such as teleconferencing: nobody would accept having to learn to use a plethora of systems in order to make telephone calls; why do we accept that for video calls?
The chapter correctly notes that data is the key (143-145) and notes that data sharing (145-147, 187, 197) may help to reintroduce competition. While it is true that data is in principle non-rivalrous (194), in practice at present it is hoarded and treated as private property by those who collect it. It would have been nice if the author had explored methods for ensuring the equitable distribution of the value added of data, but that would no doubt have required an extensive discussion of equity. It is a pity that the author didn’t discuss the economic implications, and possible justification, of providing certain base services (e.g. e-mail, search) as public services: after all, if physical mail is a public service, why shouldn’t e-mail also be a public service?
Chapter 8 documents the digital divide: access to Internet is much less affordable, and widespread, in developing countries than it is in developed countries. As the author points out, this is not a desirable situation, and he outlines solutions (including infrastructure sharing and universal service funds (157)), as have others (for example here, here, here, and here). It would have been nice if the author had explored how peering (48) may disadvantage developing countries (in particular because much of their content is hosted abroad (60, 162)); and evaluated the economics of relying on large (and hence efficient and low-cost) data centers in hubs as opposed to local hosting (which has lower transmission costs but higher operating costs); but perhaps those topics would have strayed from the main theme of the book. The author correctly identifies the lack of payment systems as a significant hindrance to greater adoption of the e-commerce in developing countries (164); and, of course, the relative disadvantage with respect to data of companies in developing countries (170, 195).
Chapter 9 explains why security and trust on the Internet must be improved, and correctly notes that increasing privacy will not necessarily increase trust (183). The Chapter reiterates some of the points outlined above, and rightly concludes: “There is good reason to raise the issue [of lack of trust] when seeing the market failures taking place today with cybersecurity, sometimes based on the most easily avoidable mistakes, and the lack of efforts to fix them. If we cannot protect ourselves today, what about tomorrow?” (189)
Chapter 10 correctly argues that change is needed, and outlines the key points: “data is the basis for market power; lack of data is the hidden danger of the digital divide; and data will train the algorithms of the future AI” (192). Even when things go virtual, there is a role for governments: “who but governments could address market power and privacy violations and respond to state-sponsored attacks against their citizens or institutions?” (193) Data governance will be a key topic for the future: “how to leverage the unique features of data and avoid the costs: how to generate positive good while protecting privacy and security for personal data; how to maintain appropriate property rights to reward innovation and investment while checking market power; how to enable machine learning while allowing new companies strong on innovation and short on data to flourish; how to ensure that the digital divide is not replaced by a data divide.” (195)
Chapters 1 through 4 purport to explain how certain technical features of the Internet condition its economics. The chapters will undoubtedly be useful for people who don’t have much knowledge of telecommunication and computer networks, but they are unfortunately grounded in an Internet-centric view that does not, in my view, accord sufficient weight to the long history of telecommunications, and, consequently, considers as inevitable things that were actually design choices. It is important to recall that the Internet was originally designed as a national (US) non-public military and research network (27-28). As such, it originally provided only for 7-bit ASCII character sets (thus excluding character with accents), it did not provide for usage-based billing, and it assumed that end-to-end encryption could be used to provide adequate security (108). It was not designed to allow insecure end-user devices (such as personal computers) to interconnect on a global scale.
The Internet was originally funded by governments, so when it was privatized, some method of funding other than conventional usage charges had to be invented (such as receiver pays (53)– and advertising). It is correct (39, 44) that differences in pricing are due to differences in technology, but only because the Internet technologies were not designed to facilitate consumption/volume-based pricing. I would have expected an economics-based discussion of how this makes it difficult to optimize networks, which always have choke points (54-55). For example, I am connected by DSL, and I pay for a set bandwidth, which is restricted by my ISP. While the fiber can carry higher bandwidth (I just have to pay more for it), at any given time (as the author correctly notes) my actual bandwidth depends on what my neighbours that share the same multiplexor are doing. If one of my neighbours is streaming full-HD movies all day long, my performance will degrade, yet they may or may not be paying the same price as me (55). This is not economically efficient. Thus, contrary to what the author posits (46), best-effort packet switching (the Internet model) is not always more efficient than circuit-switching: if guaranteed quality of service is needed, circuit-switching can be more efficient that paying for more bandwidth, even if, in case of overload, service is denied rather than being “merely” degraded (those of us who have had to abandon an Internet teleconference because of poor quality will appreciate that degradation can equal service denial; and musicians who have tried to perform virtually doing the pandemic would have appreciated a guaranteed quality of service that would have ensured synchronization between performers and between video and sound).
As the author correctly notes, (59) some form of charging is necessary when resources are scarce; and (42, 46, 61) it is important to allocate scarcity efficiently. It’s a pity that the author didn’t explore the economics of usage-based billing, and dedicated circuits, as methods for the efficient allocation of scarcity (again, in the end there is always a scarce resource somewhere in the system). And it’s a pity that he didn’t dig into the details of the economic factors that result in video traffic being about 70% of all traffic (159): is that due to commercial video-on-demand services (such as Netflix), or to user file sharing (such as YouTube) or to free pornography (such as PornHub)? In addition, I would have appreciated a discussion of the implications of the receiver-pays model, considering that receivers pay not only for the content they requested (e.g. Wikipedia pages), but also for content that they don’t want (e.g. spam) or didn’t explicitly request (e.g. adversiting).
The mention in passing of the effects of Internet on democracy (6) fails to recognize the very deleterious indirect effects resulting from the decline of traditional media. Contrary to what the book implies (7, 132) breaking companies up would not necessarily be deleterious, and making platforms responsible for content would not necessarily stifle innovation., even if such measures could have downsides.
It is true (8) that anything can be connected to the Internet (albeit with a bit more configuration than the book implies), but it is also true that this facilitates phishing, malware attacks, spoofing, abuse of social networks, and so forth.
Contrary to what the author implies (22), ICT standards have always been free to use (with some exceptions relating to intellectual property rights; further, the exceptions allowed by IETF are the same as those allowed by ITU and most other standards-making bodies (34)). Core Internet standards have always been free to access online, whereas that was not the case in the past for telecommunications standards; however, that has changed, and ITU telecommunications standards are also freely available online. While it is correct (24) that access to traditional telecommunication networks was tightly controlled, and that early data networks were proprietary, traditional telecommunications networks and later data networks were based on publicly-available standards. While it is correct (31) that anybody can contribute to Internet standards-making, in practice the discussions are dominated by people who are employed by companies that have a vested interest in the standards (see for example pp. 149-152 of the book reviewed here, and Chapters 5 and 6 of the book reviewed here); further, W3C (32) and IEEE (33) are a membership organization, as are the more traditional standardization bodies. While users of standards (in particular manufacturers) have a role in making Internet standards, that is the case for most standard-making; end-users do not have a role in making Internet standards (32). Regarding standards (33), the author fails to mention the key role of ITU-R with respect to the availability of WiFi spectrum and of ITU-T with respect to xDSL (51) and compression.
The OSI Model (26) was a joint effort of CCITT/ITU, IEC, and ISO. Contrary to what the author implies (29), e-mail existed in some form long before the Internet, albeit as proprietary systems, and there were other efforts to standardize e-mail; it is a pity that the author didn’t provide an economic analysis of why SMTP prevailed over more secure e-mail protocols, and how its lack of billing features facilitates spam (I have been told that the “simple” in SMTP refers to absence of the security and billing features that encumbered other e-mail protocols).
While much of the Internet is decentralized (30), so is much of the current telephone system. On the other hand, Internet’s naming and addressing is far more centralized than that of telephony.
However, these criticisms of specific bits of Chapters 1 through 4 do not in any way detract from the value of the rest of the book which, as already mentioned, should be required reading for anyone who wishes to engage in discussions of Internet-related matters.
Richard Hill is President of the Association for Proper internet Governance, and was formerly a senior official at the International Telecommunication Union (ITU). He has been involved in internet governance issues since the inception of the internet and is now an activist in that area, speaking, publishing, and contributing to discussions in various forums. Among other works he is the author of The New International Telecommunication Regulations and the Internet: A Commentary and Legislative History (Springer, 2014). He writes frequently about internet governance issues for The b2o Review Digital Studies magazine.