Buiness Standard

7th Dec. 2007

AUCTIONING SPECTRUM
BEST FOR COUNTRY
V. Ranganathan
RBI Chair Prof.
IIM, Bangalore
The former TRAI Chairman, Mr. Pradip Baijal IAS (retd.) makes an impassioned
plea saying Dont kill telecom by auctioning spectrum (27th Nov 07). His reason: such
policies are elitist as they make broadband unaffordable to the large masses wanting it,
and in favour of one technology or another. He also takes credit for the sea change in
mobile scenario in India from 2003 to now, by attributing this growth to changes in the
licensing regimeallusion is perhaps to the change to revenue share from lump sum
paymenttechnology-agnostic unified access, competition tariff and subsidy for mobile
towers in rural areas. He marshals additional support for his argument by saying that
both the 1995 auction for FM spectrum in India, and the 3G spectrum auctions in UK and
Europe lead to disastrous results.

He is also against Competition Act doing its job in

restraining monopolistic practices and wants an unfettered Merger and Acquisition policy,
on the ground that encouraged by Corporates, State agencies may take different views on
different mergers.

Both his positions are ill conceived and are against the cannons of

microeconomics.
Only recently your newspaper published the virtues of running an auction for 3G
spectrum through an article by my students under the caption How to run a good
auction (12th October 07). The 3G spectrum auctions in the UK, designed and executed
by Prof. Paul Klemperer of Oxford University, lead to a stunning 22.5 billion pounds
revenue or 2.5% of GNP for UK Government, compared to just 40,000 pounds for the 2G

auctions, which were bureaucratically designed beauty contests evaluating competing

firms business plans. Is this result disastrous? Certainly yes, for the firms which bid
unreasonably high, but not for the Government. An Auction forces businessmen to put
their money where their mouths are when they make their bids. An auction can
therefore extract the use information otherwise unavailable to the government. Of course
companies are taking huge risks in bidding in an auction, just as, for example, firms take
huge risks when they invest in developing a new aircraft, a new drug or bidding for a
tract of land for oil exploration. They know they are buying into a lottery that might
result in a huge loss or huge gain.

The fact that UK firms suffered losses is no

justification to say auction process lead to disastrous results. After all, phones are still
ringing in UK! In Europe, the disaster, if any, was that their governments did not get as
much as the UK auctions fetched and therefore it is unclear what Baijal is referring to as
European disaster. In the US right since 1994 the FCC, telecom regulator, has been using
Simultaneous Ascending Auction quite successfully. Two authoritative books have come
out in 2004, Auctions: Theory and Practice by Paul Klemperer (Princeton Univ. Press)
and Putting Auction Theory to Work by Paul Milgrom, instrumental in designing the US
auctions, by Cambridge University Press clearly distilling how to conduct successful
auctions and how to avoid pitfalls.

The central argument against auctioning the 3G spectrum and giving it free is the
elitist argument: viz. it will lead to increase in price of mobile telephony leading to only a
fewer consumers consuming it. This argument is blind to the fact that once the money is
paid in the auction, it is a sunk cost and does not affect the pricing in any manner. In fact

using the same faulty logic the same Mr. Baijal changed the lumpsum amount to revenue
share which he alluded to as changes in the licensing regime. He then took credit for it
by pointing the robust growth in mobile telephone, as if it is the clear result of his policy.
The real question is what is the counterfactual, or bench mark to compare? If lumpsum
licence fee had been mandated, would mobile telephony growth have been the same, less
or more? The theory predicts that it would be more, because in this case the lumpsum
amount is a sunk cost having no effect on output, unlike in the case of revenue share
when it is a marginal cost, which will reduce the output. This means that if he had
insisted on the lumpsum payment, the mobile growth would have been even higher. I
looked at Pakistan, where they collect the lumpsum amount saying that revenue share
would lead to manipulation and corruption, because the revenue can be fudged. The
growth rate is the same, as in India. By the same logic, the auction is unlikely to impede
the growth the mobile telephony or kill it.

Only Government will benefit by the

revenues, which it can use for enhancing rural telephony.

Now coming back to the elitist argument: Can prices increase, as a result of
auctions or revenue share? Naieve people think that it will because the producer has
more money to recover which he has spent. But in reality, in monopolistic markets, the
producer will tap from the consumer whatever her willingness to pay, irrespective of the
cost. This is why the same seat goes at different prices in airlines. Thus addition to fixed
cost will have no effect on price, since the producer has already tapped the maximum
WTP that is possible.

Auctions with lump sum payments being sunk costs cannot increase the price.
Lump sum payments in fact do lead to a shift of the marginal cost upward, but whether it
will lead to an increase in price or not depends on the elasticity of demand, which
depends on the ability to switch suppliers, which in turn depends on the number of
suppliers. Thus if the auction succeeds in inviting more entrants, that effect would more
than compensate the higher cost effect, even in the (faulty) revenue share model. So the
elitist argument is totally misplaced.

It is also mysterious why the auction should vitiate technology agnostic unified
access, which is desirable.

The argument for unfettered M&A, uninhibited by Competition Commission is

also unscientific and anti-consumer. Let us not forget that notwithstanding the good
growth, the Indian telecom Industry is still not fully competitive, but exhibits features of
an oligopoly, each company earning a healthy profit despite falling ARPU. Vodafone has
not bought Hutch for the love of India, but for healthy profits it sees. Mr. Sarin saved his
job by this strategic acquisition. So, there is no doubt that both TRAI and Competition
Commission should work towards greater competition in this industry.

The author clearly shows that he is now wearing the Corporate hat, but his action
of allowing revenue share makes one wonder if he was wearing it even when he was a
regulator!

This shows the need that Regulators must be well versed primarily in

industrial economics.