SECTION: IN THE NEWS

LENGTH: 2403 words

HEADLINE: PREPARED TESTIMONY OF

ELI M. NOAM

PROFESSOR OF FINANCE AND ECONOMICS

DIRECTOR, COLUMBIA INSTITUTE FOR TELE-INFORMATION

COLUMBIA UNIVERSITY, GRADUATE SCHOOL OF BUSINESS

BEFORE THE U.S. SENATE COMMITTEE ON COMMERCE

ON RADIO SPECTRUM ALLOCATIONS AND VALUATION

BODY:

Chairman Pressler, Senator Hollings, Members of the Commerce Committee: Thank you for the opportunity to appear before you.

I'll address two major issues here: spectrum auctioning, and spectrum flexibility of usage Auctions have moved from an academic theory to the

dominant orthodoxy.

They are good approaches, and I like and support them. But they are also being oversold as the silver bullet for efficient communications. This

they are not, because as they solve old problems, they also create new ones. And they do not take government out of the communications

business. It's important that you understand this for a balanced judgement.

You know all the arguments for an auction: it is better than a mindless lottery or an administrative hearing. It gets spectrum resources quickly

into the hands of users. It rationalizes the assignment process while recovering the value of the spectrum to the American public. All this is

true.

But all these reasons are secondary to the real one, namely the desire to raise cash, quick, for the government. You have to raise at least $15

billion over seven years.

Our goal is to advance a competitive national communications infrastructure. There seems to be a widespread agreement that this should be

done without government money. But we are now actually starting to do the opposite of making public investments. We are taking money out of

the infrastructure, by way of auctions, and we throw the money into the black hole of the budget deficit. For decades America's

telecommunications system was superior to that of other countries, often because they used telecommunications as a cash-cow for general

government expenses. Now we have embarked on the same road, just as other countries are leaving it at our urging.

The FCC's auctions -- they are really license auctions and not spectrum auctions -- have been innovative, and reasonably speedy as

government goes. Chairman Hundt and his staff deserve much credit. But the revenues raised tend to get exaggerated. Any auction receipts

must be offset against reduced tax receipts in the future, because license payments can be depreciated against corporate income, and are also

likely to reduce dividends. By my calculation, under quite reasonable assumptions, for each 1 $ of auction revenue tax revenue is reduced by

about 25 cents in present value.

Budget policy is the driver for the auction system. But is it good telecom policy?

An auction is a tax, a tax on future usage of an advanced technology. It retards the spread of applications.It is a barrier to entry. It's a double

hit on consumers: first, as a tax on new entrants that will be partly passed on, and second, because it will leave the market price higher than

otherwise, and therefore generate less of a competitive price reduction in the incumbent service.

It's important to recognize that the highest bidders in an auction are most likely those who will be able to organize an oligopoly to keep prices

up in order to recover the bid price. This is done, first, by bidding "consortia" of companies that would otherwise be each other's natural

competitors. Second, the high bidders, after some shake-out period, are likely to collaborate through some pricing parallelism. And third, with

spectrum flexibility, they can consolidate much easier by absorbing competitors and rival services.

Yes, we can deal with this oligopoly through antitrust law. But that brings government right back, through its role in prosecution, adjudication,

and enforcement. Some people consider antitrust enforcement morally purer than regulation, despite its sledgehammer style. They seem to have

forgotten the political and campaign involvements of the Justice department and the Antitrust Division in virtually any Administration. Thus, in

no way does an auction get government out of communications.

Even within the goal of raising revenue, the auction is not necessarily the best way to go. Economic theory predicts that if one is unable to

predict future circumstances, the buyers will underbid. Thus, the auction system results in prices that are too expensive in the short term,

because the bid price has to be tendered initially, but too low in the long term, because the bid will be too low.

And where is this going to end?

Like diamonds, budget pressures are forever. There is never enough money. This creates pressures for more auctions, especially ones of the

up-front cash type rather than pay-as-you-go type. It's one thing to sell assets for use in investment. But this a situation of pure consumption.

It's like New York City solving its budget problems by selling off Central Park to developers. So this isn't even good budget policy.

Therefore, my strong recommendation is that you return as much as possible of the auction revenues to the telecommunications system, as a

source of support, for example, to rural communications, educational computer communications and television, and tele-medicine.

Domestically, everybody will get into auctions, because everybody needs money. Local governments will start auctioning off cable licenses, but

not to the first cable franchise, where renewal is protected by law and politics, only to its competitors.

Also, American firms will pay dearly for this auction system abroad. There will be auctions everywhere, in any country chasing hard currency,

and our companies will do a major part of the paying. The ITU in Geneva will also get into auctions for spectrum and orbital allocations. After all,

the US government's spectrum is often derivative of an earlier allocation by some international agreement. Such auctions will give international

organizations an independent source of income. Then, there will inevitably be preferences for all kinds of countries, with the concept of

preferences for small businesses carried to small and poor countries.

It can be argued that at least the auctions put a foreign government's decision process into the open, away from influence peddling and

corruption. This might be true in some cases, but the opposite to liberalization is just as likely. A revenue-starved country is likely to sell off a

monopoly licenses, because if it will fetch the highest bid price. And the non-political nature of the auction can be easily undermined by various

preferences for local ownership and content.

The alternative to the present auctions is not to return to the wasteful lotteries or comparative hearings of the past, but to take a further step

foreword, to full openness of entry, which becomes possible with fully digital communications. There is a free-market alternative to the present

auction system: I call it the open entry spectrum exchange system, and I've been thinking about it lately. In this system no oligopoly can

survive because anyone can enter. Large, small, white, black, male, female, American, foreigner. There is no license, and no up-front spectrum

auction.

When congestion happens, a clearinghouse of users allocates access by charging a market-clearing congestion price. Think of it as a commodity

exchange that trades spectrum access in spot and future trades. In practical terms, it would be a computer that clears markets in allocations,

and sets congestion prices based on supply and demand. These congestion fees would then be government revenues.

This system converts fixed costs of entry by license auction into marginal costs of usage. It therefore has a major stabilizing function because

marginal costs are otherwise so low as to fail to cover total cost, and hence encourage collusive pricing. It encourages a spectrum- agility that

continuously seeks the cheapest spectrum for use for a particular application. And it smooths the revenue flow to government, away from the

one-shot deals.

It is true that without secure long-term tenure, there may be lower investment. On the other hand, greater competition spurs innovation. One

needs to balance certainty with contestability. Uncertainty exists in every business. One can never control every input. Where certainty is

considered necessary, futures markets for capacity will evolve to reduce risk.

I am not suggesting that the open entry spectrum exchange will solve every problem oftoday's auctions. It does not. The point is, however,

that superior assignment systems can emerge with experience and technology. There is, therefore, no urgency to commit great amounts of

spectrum to today's form of auction just for budgetary reasons, because once it's gone, it's gone.

Let me now turn to spectrum flexibility.

"Flexibility" always sounds good, and the inflexibility of the present system creates a major drag to innovation and efficiency. But flexibility, too,

has a down-side that you need to consider for a balanced judgment. There is no need for a one-size-fits-all approach to flexibility, across all

spectrum bands. Let me therefore advocate "flexible flexibility."

Different approaches are appropriate for different bands. I have three transceivers here, technically fairly similar. The first is for aviation use in

air traffic. Simply by using it improperly, I could disrupt and endanger air traffic. Therefore, users should be tightly regulated and given very little

flexibility. The second handset is an amateur radio. Here, we want to encourage flexibility in technical experimentation and public service, but

not in the non-profit status, just like for a public park. And the third is a cellular phone, provided commercially by private competitors, and the

arguments for flexibility are much stronger here, especially if the license was paid for.

Flexibility means supplier choice. But market prices do not necessarily reflect all social value, becausesocial value, to economists, also includes

consumer surplus, that is, the benefit to a consumer above the sale price. For broadcasting, the surplus of social over private value has been

estimated to be seven times as high as market price (Noll, and McGowan, 1973). Thus, if a broadcaster switches out of TV, the impact goes far

beyond his private transaction.

Similarly, the departure of a competitor may lead to higher prices for the users of a service, which is also pan of social cost. Indeed, such

departure could be subsidized by the remaining providers, who would then face less competition and raise prices.

Flexibility makes most sense for new commercial spectrum bands. But flexibility would be a major windfall for existing services and bands, and

skew competition in their favor. Therefore, new flexibility for old users would, to maintain free-market purity, have to be combined with a

re-auctioning of already occupied spectrum. But that would be unfair to the many incumbents who have acquired the license in private

after-markets. So the compromise might be not an auction but a fee on the incremental income on services beyond the original license grant.

But this would make everyone unhappy, market purists and stakeholders.

Let's also think what full flexibility means, and realize that full flexibility means the full backdoor deregulation of interconnection, common

carriage, universal service, foreign ownership, and many of the safeguards you just put into the telecommunications reform bill. Why? Because

full flexibility means that a service provider could simply opt out of most rules that apply to his service by creating a do-it- yourself service

category. So with truly full flexibility, we'll have new-type broadcasters without public-interest obligations, new-type mobile companies without

common carriage, and new-type phone companies without interconnection, universal service, and rural carriage of last resort. Many of these

things will happen and should happen with full competition. But they should be instituted directly by Congress, not indirectly by letting firms opt

out of existing rules.

The pluses and minuses of flexibility are similar to those of real estate zoning. If "anything goes" on every band, you'll have some negative

spillovers on neighbors. Different services have different balances of complexity for transmitter and receiver. In the extreme, radar or radio

astronomy cannot tolerate any interference. A broadcast signal in the midst of low-power two-way mobile phones could impose a greater

equipment cost on the mobile users, and probably also on broadcast viewers, whose signal purity would need greater protection. Single-band

equipment tends therefore to be simpler and cheaper. Inevitably, stricter technical and operational standards will have to be set once users are

intermingled across bands. Similarly, there will be rules against some undesirable usage, for example, for gambling.

Thus, it would be naive to expect government to fade away with flexibility. There will be a substantial enforcement effort necessary to patrol

the laissez-faire ether in order to keep the users technically apart.

Therefore, it's possible that flexibility instead of reducing all restrictions on all bands, will spread any and all restrictions to any and all bands.

Nor is it obvious that the auctions with usage flexibility will always generate the best long term usage where there are positive network

externalities, that is, where each additional user benefits the previous users. In such a situation, a new service without the critical mass of a

subscriber base would be elbowed out by an established service, unless it had access to very patient capital. By allocating some spectrum in

the direction of a new service, we are giving ourselves the option to create competitors to existing market power. For example, it is better to

encourage competition to cable TV by allocating a band to a competing service than by direct price regulation. Why give up that policy tool?

In conclusion: you should approach auctions and flexibility in a flexible manner. One can provide for different approaches for some spectrum

bands. Don't abdicate your responsibility in allocating spectrum resources toward uses that in your collective judgement are in the public

interest, such as for national security, science, technology, competition, or economic innovation. Many allocative judgements should come

through the market; others are yours to make, or for a trusted delegated agency. The challenge to you and to the American public is then to be

able to observe what the invisible hand does to this invisible resource.

Thank you, Senators.

LOAD-DATE: August 12, 1995