I have been having a debate with Paul Lockett on Tim Worstall's site, which I have found very interesting and illuminating. The topic was the TPA's green-tax-calculator, and what it said about costs of carbon in this country. I claimed that one thing it showed was that road-use is overcharged and domestic heating is undercharged. Paul gave some very interesting reasons, which I hadn't considered before, why road-use is not as overcharged as I (and I suspect many others) tend to think.
He has certainly persuaded me of his basic point, which (if I have understood it correctly) is that the crude comparison that many of us make between costs of construction and maintenance of roads on the one hand, and revenue from vehicle excise and fuel duty on the other, cannot be taken as a rough indicator of the extent of overcharging (whether for "green-ness" or any other attribution), because there is an element of charging for the use of a scarce resource (road-space) within that balance. As you can see from the exchanges on Tim's site, I still think that there are reasons to believe that the government is charging us more than a market price for use of the roads, but I guess we won't know unless we actually move to full road-use pricing. In my opinion (and this is something I didn't put into the debate, because I am happy to accept the concept, if not the reality of road-use charging), the transaction costs and civil-liberties implications of road-use charging exceed the economic benefits of more accurately tailoring charges to supply and demand, so in a sense, I hope we never find out whether we are being over- or under-charged. But it is an interesting thought experiment.
Anyway, I expanded the debate into a question of the merits (or otherwise) of government auctions, on the basis that the question of whether there was a high initial capital value in a road-use charging system would depend on whether the market created by the government was truly competitive or embedded monopoly privileges. I (unwisely) cited the 3G auction as an example of a bad government auction of monopoly rights. Paul observed:
"I find this comment extremely odd. What else would you propose to do to allocate the use of spectrum, which is a scarce resource? The government hasn’t created a system where competition is limited in the case of spectrum, it is inherently limited."
To which I replied:
"I agree with your distinction between natural scarcity and artificially-enhanced scarcity. This wasn’t the best example for me to pick. I should have used the example of the Non-Fossil Fuel Obligation, which was the first case where I became aware of this problem, but it’s rather obscure. In the case of NFFO, government created artificial scarcities of unknown quanta for a dutch auction. Their monopoly position was so effective that they drove prices down strongly. The problem was that it was so effective and people were thus so desperate to win one of the unknown number of contracts that would be let for their technology, that the optimists bid down the price below where most projects were viable and many realists were shut out. NFFO ended up being a tremendously successful way of driving the price down to a level at which it prevented development of the thing it was supposed to encourage.
The 3G auction nearly had the same effect, delaying roll-out, and nearly bankrupting some of the winning optimists and shutting out some of the realists. But in this case, the water is muddied because the scarcity, as you say, is genuine. Someone would have taken the profits from the excess of demand over supply, and who better than the government on our behalf? All the same, I would have structured it in a different way, separating the natural-monopoly infrastructure-provision part from the service-provision part more clearly (analagous to the structure of the electricity industry in that brief halcyon period after supply and distribution had been split but before Sir Callamity McCarthy* allowed the competitive market to be undone by vertical-integration), and creating a more flexible market for accessing the infrastructure. This would have maintained the competitive threat from new entrants and removed the need for regulation of this part of the business, with tighter but limited regulation (of compliance with the rules, not of prices) over the natural-monopoly part. Having the revenue from sale of bandwidth-rights come in to the infrastructure-provider rather than the government in the first place would make the provision of that infrastructure well-funded and relatively low-risk, which would have helped to get the systems built, rather than being delayed by cash being sucked out of the system by the government maximising its revenue at auction. The risk and benefits could be further shared with society, by government-underwriting of minimum returns for the infrastructure-provider (highly unlikely ever to be needed), and provision for a proportion of profits above the minimum returns to go to the Treasury. This would have kept the cost of money as low as possible, getting the systems built, maintained and expanded as quickly and cheaply as possible.
You may say that if idiots want to overbid (or under-bid in a dutch auction), that is their lookout, it is the market working as intended, and not a sign of a bad mechanism. But we see it time and time again where government is letting contracts for monopoly positions. We have seen it in many public-sector construction projects, where standard practice is to bid a non-viable price in order to win the contract, and then hope to claw it back by renegotiation once the project is under way and the government is frightened to let it fail or be further delayed. That is the real reason why so many of these projects go over-budget and over-time - they were never going to come in on-budget and on-time. The amazing thing is that some occasionally do, not that so many don’t.
The incentives in government-auctioning are to drive honest men out of the market and encourage the crooks. It also tends to inflate ultimate costs, because it is more expensive to put right something done badly than to get it right in the first place. The government is in a unique position, and should try as hard as possible to design mechanisms that ameliorate this impact, even at the expense of reducing the amount of revenue raised. But of course, the public-choice incentives for the government strongly encourage the opposite behaviour."
I have created this post, partly because it is a topic on which I have strong negative experiences (in NFFO) that I wanted to highlight, partly because I don't feel that I have properly explored the alternatives and whether they are any better, and partly so that, if the debate on this subject were to continue, it wouldn't have to divert the debate on road-use charging on Tim's site.
* I was going to explain in a note who Sir Callum McCarthy is, but the incompetent, lackadaisical, credulous fool deserves a post all of his own.
Comments
3G
"All the same, I would have structured it in a different way, separating the natural-monopoly infrastructure-provision part from the service-provision part more clearly"
Before I comment on this further, I'd like to clarify this point, because I think it's key. Is the 3G infrastructure definitely a natural monopoly? It isn't something I know a great deal about, but I was under the impression that the networks had their own infrastructure.
Natural oligopoly?
I've never heard the term, but perhaps a "natural oligopoly".
The physical infrastructure, as I understand it with my limited knowledge, runs over a pair of relatively narrow frequency ranges (one up, one down), but (through multiplexing) allows multiple channels on the same frequencies. In theory, one could have large numbers of channels through use of different spreading codes and timings, but the more channels, the less bandwidth there would be on each channel, so there are diminishing returns from channel expansion. One could, I suppose, also increase channels without decreasing bandwidth (or perhaps have greater bandwidth to divide up), through use of smaller cells using higher frequencies. I believe this is part of the 4G concept. So I suppose this is only a "natural oligopoly" if one accepts that the frequencies must be limited to those used.
If one were to reject the frequency constraints, and argue that the government could allow use of more frequencies, then I suppose we are in the situation of an artificial scarcity, and the situation becomes closer to the NFFO situation.
If one accepts the frequency constraints for pragmatic reasons, then I'd have thought "natural oligopoly" was a fair description. One could have many networks with many overlapping transmitters, but they would each be serving up a smaller share of the available bandwidth than if a tighter limit were placed on the number of networks. Some compromise has to be struck.
I believe, though, that you could have as many carriers as you like carried over the available bandwidth. Obviously, you would still be dividing up the same amount of bandwidth, but the bandwidth required for carrying voice (for example) is quite small compared to the bandwidth available, so there is not the same illogicality to having many carriers as there is to having many networks. This is only an inference, based on the availability of roaming agreements, and the presence of companies like Virgin Mobile, who don't appear to have their own network.
I could be wrong about all this.
natural vs deliberate scarcity
From my perspective these kind of government auctions tend to fall into two areas. The first is auctioning off licences to exploit a resource which is inherently limited, such as spectrum and oil drilling rights. The second is auctioning off licences to exploit a resource which has been deliberately limited to prevent a tragedy of the commons, such as pollution rights or fishing quotas.
I think it's the second area which is more complicated, because there are two alternative ways of creating a market to prevent a tragedy of the commons; you can set the price and allow the market to decide the quantity (as with fuel duty) or you can set the quantity and allow the market to decide the price (as with cap and trade). In general, I think the former is preferable, as it doesn't create the inflexibility of an absolute limit, but there may be circumstances, such as with fishing quotas, where capping may be the better option.
I think the major problem that arises with spectrum auctions is that governments go too far in specifying how the frequencies must be used, rather than allowing the market to determine the most efficient use of each frequency. If the frequencies were auctioned off with the holders free to use them as they see fit, then it is only natural scarcity being auctioned, but as soon as specific uses are laid down, there is an element of artificial scarcity being auctioned too. It's akin to the way the planning system makes residential land more valuable by restricting development on other plots.
You said: "I would have structured it in a different way, separating the natural-monopoly infrastructure-provision part from the service-provision part more clearly"
With networks which have been previously operated by the state as monopolies, I tend to agree. For example, privatising the National Grid in the way it happened was never likely to generate competitive benefits in the way that privatising the rest of the supply chain has. I think it would have made more sense to turn the National Grid in to some form of co-operative with a common carrier obligation, which would have allowed it to operate with far less regulation.
With new technologies such as 3G, I'm far less keen on that approach because there is no pre-existing monopoly operator, so it is perfectly possible that competing infrastructure may arise, as seems to be the case. Tying the suppliers into a common infrastructure from the outset would have created a monopoly which could have stiffled innovation.
In terms of a mechanism to achieve the allocation of spectrum, etc., I increasingly favour the self assessment approach over the absolute auction approach. That was something I detailed in my blog last year in relation to land, but it would also work for spectrum, oil drilling rights, or even, as I detailed in another post, completely artificial monopolies, such as patents.
Mostly agreed
I agree with most of that (e.g. preference for price over cap-and-trade, the reasons for it, and the impossibility of creating a competitive market for electricity transmission).
"With new technologies such as 3G, I'm far less keen on that approach because there is no pre-existing monopoly operator, so it is perfectly possible that competing infrastructure may arise, as seems to be the case. Tying the suppliers into a common infrastructure from the outset would have created a monopoly which could have stiffled innovation."
Unfortunately, the practical constraints on the physical services underlying 3G prevent much innovation and competition - they have to conform to very strict rules (e.g. to ensure cooperative multiplexing) in order for the service to be possible. You can have multiple networks, so it doesn't have to be a single common infrastructure, but I can't see an easy way to avoid oligopoly privileges at the network level because of the practical limits on bandwidth and number of networks. A clearer separation of networks from carriers, and capture of the social benefit through share of network profits rather than auction of network+carrier monopoly privileges, would reduce the harm caused by those unavoidable privileges, compared to the way we have gone about it.
"In terms of a mechanism to achieve the allocation of spectrum, etc., I increasingly favour the self assessment approach over the absolute auction approach."
That is an excellent way of establishing the real (i.e. subjective) value of someone's property, for goods that are suitable for the process. For instance, it works for undeveloped land valuation, or property valuation, but not for valuation of the land under a property, because of the transaction costs of moving the property, as people commented.
It's very similar to the shotgun method for resolving ownership where two sets of shareholders cannot agree on future strategy. Both parties write their valuation of the company on a piece of paper and stick it in an envelope, and then the envelopes are exchanged and opened. Whichever party has the higher valuation has to buy the other party's shares at that valuation. Same principle. Much better than arbitration or calculation.
I'm not sure that it is practical for mobile-phone bandwidth, though. If a carrier could lose their bandwidth at a stroke if someone was willing to pay their self-assessed price, you could have millions of people with a service contract who suddenly found that their service-provider was cut off.
Incidentally, I completely agree with you about patents. I've been a linux user for about 13 years now (Mandrake/iva for the last 10 or so), even running it on my work laptop, and am a FFII supporter. Your solution is intriguing, but I'm not sure that extracting value for the public purse does much to counter the negative impact of patent-abuse. It felt to me like your system would hand more power to the big companies who abuse the system, who would be the only ones who could afford the risk and cost of the protection.
I would simply push for more limited application of IP protection (patent or copyright), with shorter protection-periods (particularly on copyright), and many exclusions and limitations of what can be protected, for instance making software copyrightable, not patentable. In the medical field (which is one of the most contentious areas), rather than reducing or eliminating IP protection, I would look for a different commercial arrangement for the purchase of drugs, as a way to balance the need to incentivize research with the counter-productive current approach to pricing. I'd like to see the drug companies charge an annual lump-sum to health services or purchasing organisations for the right to purchase the drug, and a small charge per unit. The lump-sum would recover the cost of the R&D and the unit charge would cover the cost of production etc. Everyone would benefit, compared to the current system of trying to recover R&D costs through the unit charges.
Pricing
Bruno: "If a carrier could lose their bandwidth at a stroke if someone was willing to pay their self-assessed price, you could have millions of people with a service contract who suddenly found that their service-provider was cut off."
In terms of practicality, I would envisage a hand-over period being part of that kind of spectrum and location pricing.
"It felt to me like your system would hand more power to the big companies who abuse the system, who would be the only ones who could afford the risk and cost of the protection."
I'd expect exactly the opposite. At the minute, many of the big players seem to take a "patent everything" approach, which the smaller players generally don't have the resources to do. That then allows them to tie up the market by using their extensive patent portfolios as a barrier to entry. If each of those patents carried with it a cost, companies would be less eager to patent ideas other than those which are genuinely innovative and profitable in their own right.