What is good for a free market could be bad for a controlled market
A public policy function of the government is the allocation of limited national resources, such as radio frequency spectrum, urban land, coal blocks and natural gas. Of late, policy makers and regulators have been trying to spot the methodology that will optimise natural resource allocation. In this context, a look at how methodologies evolved for RF spectrum allocation would be instructive.
Historically, RF spectrum, a limited natural resource, is allocated by governments through the so-called Administrative Method, also called ?first come, first served (FCFS). This seemed fine till the early 1990s, as demand hardly exceeded supply. Though the first cellular system was introduced in 1979 in Japan?followed by the US and Nordic countries in the early 1980s?the handsets were bulky, costly (more than $700) and cumbersome. Based on analogue technology, their performance was bad and spectral efficiency, poor. That is why the demand for spectrum did not exceed supply till the mid-1980s.
Once the demand exceeds supply, the administrative method can hardly be justified. That leaves us with two other options i.e., the so called ?Beauty Contest? and the ?Market Based? approach. In the mid-1980s, beyond the monopoly telephone operator, a second licence was granted in Germany, France & the UK based on the beauty contest, i.e., comparative evaluation of bids, by a screening committee. Even in the US, the FCC had to convince the government to switch over to auction, from lottery?the method followed to grant cellular licences till 1992. The US Congress was initially opposed to auction, until FCC, the telecom regulator, convinced the government of its benefit to the exchequer. Only with the passage of the Omnibus Budget Reconciliation Act in 1993 did FCC finally adopt the auction or market-based approach.
An early advocate of the market-based approach for natural resource allocation was Leo Herzel, who in 1951 proposed auction for spectrum allocation. In parallel, another economist Ronald Coase-?who won the Nobel Prize in 1991 for his pioneering study on distribution of property rights to individuals by law, contract & regulation?has been advocating the concept of spectrum rights?transferable and valuable on a market?since 1959. The impetus behind market-based approach has been building up ever since.
However, the approach found favour with policy makers and regulators only in the 1990s, when demand exceeded supply for this natural resource and the ?beauty contest? was given up over criticism of its politicisation in Europe, particularly Germany. A kind of auction fever gripped many countries in the 1990s. New Zealand was among the first, followed by Australia and the US, where the world?s best micro-economists were engaged to design simultaneous ascending order auctions. The finance ministries of these countries relished the revenues.
The opportunity to assign frequencies for 3G mobile services was used by many European governments as a test bed for developing the finest auction techniques and also to raise revenue to reduce the fiscal deficit. The results were quite dramatic. The UK and German governments raised a record 35 billion and 50 billion euros, respectively, in 2000. The enormous 3G debt of British Telecom, Deutsche Telecom, France Telecom and KPN was a staggering 185 billion pounds in 2001, and a telecom slump followed.
The high biddings were blamed on uncertainties relating to 3G services. The technology was new in 2000, and the managers, who bid these astronomical prices, were unfamiliar with the new technology platform and the effect of alternative broadband mobile technologies like IEEE 802.11, on the broadband service market.
Even India adopted the bidding process to grant two 2G (GSM) licences for the four metro cities (Mumbai, Delhi, Kolkata & Chennai) in 1992, following the deregulation of the telecom market in 1991. The spectrum came bundled with the licence, so the bids were really for the frequency resource.
In 1994, cellular bids were invited for 18 telecom circles both for entry to the market and for the yearly fee for the licence duration. NTP 1999 changed the latter to revenue share. Subsequently, the third licence was granted to PSUs i.e., MTNL & BSNL. Even the fourth licence for cellular services was granted based on transparent bidding in 2001. This well established policy of competitive bidding was given up in 2003, after introduction of the so-called unified licensing regime, and a FCFS policy introduced in violation of best international practice.
In the UK, following the widespread criticism of 3G auctions, also called winner?s curse, which resulted in British Telecom incurring huge debts and triggering a telecom slump, the British Telecom Regulator OFCOM made a detailed review to decide the optimal method to allocate spectrum. This was done through a consultation document released in June 2005.
Through the consultation, which involved top economists of the world, OFCOM concluded that auction could be a more efficient process in terms of outcome than other processes such as FCFS or beauty contest, and therefore better able to promote the optimal use of this scarce national resource. Subject to the details of its design, the auction should allow the market?which has more information available to it?rather than the regulator to determine who would be the most efficient users of the spectrum bands, by assigning licences to users with the highest valuation.
OFCOM also considered that clear and simple criteria to identify the winning bidders offer the most transparent and non-discriminatory method. This is because in auctions, licences are awarded to those bidders prepared to pay the most. Auctions are therefore likely to lead to the spectrum rights being assigned to users that value them most highly, which will be those who are likely to use the spectrum most efficiently.
According to OFCOM, a FCFS process would not be appropriate, as the first applicants may not be those who make the most efficient use of this scarce resource. A comparative selection or beauty contest would not be appropriate because of risks to objectivity.
The Indian Supreme Court, while delivering its judgment on telecom 2G licences in February, has asked the government to adopt auctions as the method for allocation of all natural resources while cancelling 122 telecom licences granted by minister A. Raja. The government has rightly made a Presidential reference to the court, seeking to know if the auction method should be adopted for all natural resource allocation.
Today, the country is seeing a raging controversy over coal allocation. An issue to consider here is that there is a basic difference between spectrum, which is an input for telecom service market that is fully liberalised since 1991, and the captive coal market. Coal is used as a captive market for production of electricity, cement and steel, which are vital inputs for infrastructure building and industrial growth. Whereas the Trai, since 2002, has not regulated tariff for telecom services and left it to the market forces in a fully competitive open market, coal prices are administered because it is an essential input for generating power, which is supplied by state electricity boards at subsidised prices to help industry and agriculture.
A lot of uncertainties are attached to gas or oil exploration or mining of coal in remote and inaccessible areas, therefore bidding a realistic price for these resources in a captive market will be difficult and is likely to affect the price of the end product i.e., electricity, gas, steel and cement. As some analysts have rightly pointed out, maximising revenue from resource cannot be the end objective of all government policies.
In coal, the issue is more complex, as the state governments also have a say, whereas in telecom, which is wholly a central subject, policy making is much easier. In the case of coal, a number of state governments had opposed auctions, and the policy of allocating coal blocks is based on a beauty contest i.e., comparative evaluation of allocating coal by a high powered screening committee in which chief secretaries of states have a strong say in the selection of allottees. For adopting auction, the existing legal framework needs to be changed with the consent of the states and the market, fully liberalised.
When telecom operators bid for spectrum, they do not face the uncertainties faced by the allottees of coal, oil or gas and other scarce natural resources involving exploration. The spectrum for 2G, 3G, 4G services are assigned to telecom operators after much coordination not only at the national level but at the international level by the Wireless Planning Wing of the ministry of communication and the International Telecom Union. They are also assured of equipment supply, and can fix tariff based on market demand and competition.
There will be occasions when welfare economics would require the governments of developing countries like ours to set prices below cost to subsidise an essential input for the growth of industry and agriculture, as also for building infrastructure. Therefore, the Presidential reference to the Supreme Court is fully justified. It is expected that the apex court will clarify the matter, and uphold the government?s right to formulate policies in the best interest of the nation.
The author is former member, Trai/Telecom Commission
