Not a high price to pay

Consumers won’t bear the costs of high bids for 2G spectrum.

Updated: February 26, 2014 9:43 am
Whether or not firms face a ‘winner’s curse’ is a commercial question. They must believe that there was an economic rationale for their bids, or they would not have paid so much. PTI Whether or not firms face a ‘winner’s curse’ is a commercial question. They must believe that there was an economic rationale for their bids, or they would not have paid so much. PTI

Consumers won’t bear the costs of high bids for 2G spectrum.

The 2G auction earlier this month was, from the point of view of government revenues, a roaring success, raising Rs 61,000 crore. The astronomical amounts telecom companies bid for spectrum are causing an increasing number of commentators to argue that they overpaid and now face a “winner’s curse”. Whether or not this is the case is a purely commercial question, although lay commentators should bear in mind that the firms themselves must believe that there was an economic rationale for their bids, or else they would not have agreed to pay so much in the first place.

The more contentious question is whether this “winner’s curse” will harm consumers, either through higher prices as providers pass the tremendous spectrum costs on to consumers or through a slower roll-out of advanced telecommunication services because the burden of paying for spectrum reduces the cash available for investment. Standard economic theory would say that the first mechanism is fallacious, while the second seems implausible.

Let’s start with the former claim — that higher spectrum costs will be passed on to consumers. The first question to ask is, suppose spectrum had been handed out free of charge, what price would a telecom company charge consumers? Presuming that it is competently managed, the answer is obvious: it would charge the price that makes it the greatest possible profit, given the competition it faces from other firms in the industry.

Now suppose the firm had paid Rs 10,000 crore for its spectrum, would it charge a higher price than if it had paid nothing at all? The answer is no: in the first case, the company was charging the price that gave it the highest possible profits given the competition it faces. Since the spectrum auction has not changed the level of competition in the industry, it must be that firms will charge the same price as if they had paid nothing. Intuitively, any attempt to recoup the cost of spectrum by gouging consumers will be counterproductive — a firm that tries to do so would drive its customers to competitor companies and see its profits fall.

Moving on to the second claim — that higher spectrum fees could reduce the money available for telecom companies to invest in new technology and services. This argument has a ring of truth about it. Surely, if firms have spent crores of rupees on spectrum licences, they will have less to spend on other things?

However, this argument neglects the possibility that firms can fund investment through borrowing. For example, suppose an operator believes it can get a healthy return from rolling out improved data services in Delhi but as a result of overpaying for spectrum, it does not have the spare cash to do so. Surely it can pitch this business case to investors and borrow the money? This is particularly true given the multinational nature of India’s telecom operators.

Admittedly there are exceptions to the above argument: if the cost of paying for spectrum was so burdensome that it threatened the financial viability of a company then it might find it impossible to borrow at reasonable rates and, as a result, let profitable investments in infrastructure pass it by. Similarly, if it lacked access to finance, it might find itself unable to borrow the money needed to invest. However, neither of these constraints appears relevant — the major Indian telecom operators do not appear to be at any risk of insolvency and since they are large, often multinational, companies, access to finance is unlikely to be a concern. If investment in India is as profitable as it is claimed, then telecom firms will find financing from somewhere. If it is not, whether they overpaid for spectrum is neither here nor there.

Finally, it is worth noting where spectrum auctions fit into the bigger picture. First, spectrum auctions are transparent: the licences go to the highest bidder, not to a firm chosen by government diktat. This reduces the scope for national assets to be handed out on the cheap to those with the right connections. Second, they are lucrative: given the fragile nature of India’s tax system, it should not turn its back on methods that are proven to generate significant sums of government revenue without discouraging economic activity.

The writer is a senior associate in the antitrust and competition economics practice of Charles River Associates, London.
Views are personal

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  1. A
    Anirban Pal
    Feb 27, 2014 at 9:16 am
    Given the trend in the industry, wouldn't mergers and acquisitions reduce compeion in the longer run allowing carriers to raise prices?
    1. H
      Harish Kumar
      Feb 26, 2014 at 8:51 am
      If there is total transparency in auctions and tele companies have reasonable profit in mind, Government gets its due share in auction and the consumers get it at a reasonable rate, all the three would be happy.
      1. M
        Feb 27, 2014 at 1:42 pm
        Why does the author not even consider the possibility that these telecom companies will behave like a cartel, and so not be motivated to charge compeive prices? What does he see in the character of these firms and their ability to buy political influence and judicial istance that the rest of us don't?