The news is that the telecom minister in appointed prime minister Manmohan Singh’s cabinet finally resigned. The charge against him is that he sold off some spectrum at prices that brought in $X in revenues to the government, which is about Rs 1,70,000 Cr (~$40 billion) less than $Y which would have been the revenue had the spectrum been sold using some other method such as an auction or whatever. Time for me to inject some sanity in the insane figure of Rs 1.7 lakh crores being bandied about by the media.
Let’s get back to the basics first. What is spectrum? It is a natural resource, and naturally scarce. The word ‘scarce’ is not an absolute measure, only a relative measure. Two major factors determine the abundance or scarcity of resources. First is the demand-supply equation. If demand is low relative to supply, we have abundance. Second, technology. Technology can make an otherwise scarce (and therefore valuable) resource immaterial, inconsequential, and irrelevant. (With apologies to Perry Mason.)
For example, petroleum was not a scarce resource around the early 19th century CE. Where it was found, close to the ground, it was a pollutant. The supply was low but the demand was even lower. But technology come around and suddenly demand increased. More supplies are located. With time, supply and demand both take off. Depending on which one grows faster, the price goes up or down. Technology gets even better and you get more bang out of a gallon of petroleum. But demand goes up even more while the stocks start depleting as it is pumped out of the ground at a rapid rate. The price goes up.
Once again technology will step in. Different energy sources will be developed (direct or indirect solar, fusion, etc) and once again petroleum will become irrelevant. The wheel would have turned full circle.
Technology is funny like that. It giveth and it taketh away. Copper demand increased because telephone systems used twisted copper pairs for carrying the signals. Then fiber-optics and wireless technologies made copper wires obsolete.
Spectrum used to be absolutely free at one time. Imagine the year 1900 CE. You could not give it away because generally people did not know what it was. The technology did not exist. Later, technology made it valuable because the demand exceeded the supply. But with even more technology, the efficiency of use of spectrum went up.
Spectrum is funny like that — it is almost infinitely elastic. You can burden more and more information on the same bit of spectrum with better technology. That is both good news and bad news.
Good news because it means that in the long term, we are not likely to ever run out of spectrum (unlike say petroleum, which in some sense we will actually run out of.) The bad news is that it is hard to “price” spectrum.
Spectrum, like any other resource, can be priced using the standard method of asking what anyone is willing to pay for it. That willingness to pay depends on the benefit derived from its use. The end user has a downward sloping demand curve — which basically says that the higher the price per unit, the lower will be the quantity demanded by the user. The user will not pay a price that exceeds the benefit the user derives from consuming that unit of resource. At some price point, I will simply not make that call.
How much the consumer values something determines its value and consequently (through a set of filters imposed on it through various factors such as regulations, technology, etc) the prevailing price of that something.
Then from consumer behavior, one can figure out through a series of simple steps how the producer will behave. Profit maximization (or some other optimizing strategy) will be used — depending on various factors such as the cost of production and the degree of competition. We don’t need to go into the details here. I only mention this to indicate that all this is quite well understood and therefore predictable.
Now comes the interesting bit. Actually this is the most important bit in this post. If you know this, don’t bother reading any further. Here it comes. Ready?
There is no such thing as a price for spectrum. The price of spectrum is indeterminate. It can be anything — from zero to infinite.
The rest of the post will explore those interesting bits. Why? Because if we understand that, only then we can understand that the claim that a minister of the UPA government “scammed” the nation to the tune of untold crores of rupees is a meaningless notion. In other words, the harm that Mr Raja did is not as easy as the press would have you believe.
But you will say, “Wait a minute. I don’t have the time to go into this. Just give me a short answer. All I want to know is where did Raja stash the Rs 1.7 lakh crores loot? Did he put it in a secret Swiss bank account? If he had not stolen that money, India could have built one crore (10 million) houses for the poor each costing Rs 1.7 lakhs? Isn’t that the greatest theft in the history of mankind?”
Actually no. What Raja did was mis-price a public asset. That is economically wasteful in the sense that it is inefficient, regardless of whether it is illegal, or fair, or moral.
(Digression: What’s economically inefficient? And how is it different from “fair”? Suppose there’s a cookie we wish to divide between the two of us. If we agree that we have equal claim to the cookie, a 50-50 division will be fair. But when breaking the cookie, I take 70 percent of it and hand you only 30 percent, it will be unfair but the division will be “efficient” — no bit of the cookie is wasted. The process of division would be inefficient if when dividing the cooking, I clumsily let 20 percent of it fall into the the garbage can. Regardless of how we divide the remaining bits of the cookie between the two of us, the process is inefficient because it leads to “social waste” — that no one gains and at least someone loses.)
Mis-pricing spectrum leads to inefficiency or social costs. There are several avenues. First is a loss to public revenues. This is not an easy one at all. Why? Because it is a public asset which the public is selling — thus getting revenues — but then it has to pay rent for the use of the asset that it has sold.
Imagine that I sold my house and then rented it back from the new owner. Assuming that I had to continue to live in the house (for some reason I do not have the choice of renting elsewhere), the higher the price I got for my house, the higher the rent I will have to pay to the new owner. That is, the buyer will only get into the deal provided the flow of rents at least covers the price of the house.
Sure you can sell spectrum very dearly but eventually that cost is passed on to the average citizen in term of higher price for using spectrum. You see, the telecom firm is merely facilitating your use of your own spectrum. It’s just an intermediary. The higher the firm’s costs, the higher the price.
Think about it. And we will continue to inquire into this fascinating subject in later posts. This is a fascinating case study which has the potential to teach us essential basic economic reasoning.
[Go to Part 2.]
Atanu Dey : Life is a Random Draw 
Well at this point I must thank you for your blog and the basic idea of functional economics it has given out to the extent that I can get an idea of why things around us function the way they do . I for one fell for the media thingy about the 1.71L crores as if it been stashed away in a bank account far far away .
Sometimes PhD-s don’t really need to publish research papers to make an impact , maybe writing a book or a blog to bring to the “masses” what their subject is all about , is just as impactful 🙂
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I had this viewpoint right since learning about the scam – a reason why owning a cellphone is so low compared to say the US. What I could not get from the media is what motive Mr. Raja had in doing what he did. I am prepared to eat my own hair if it was out of public good.
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Dilemma indeed! If we let “market” decide the price of the spectrum, then the proper way to allocate it is through an auction. However, that drives its price up, which is passed on back to us- the citizens/consumers. So, if the end goal is to best serve the citizens, then how should we best allocate the spectrum?
Any thoughts from the author or the readers here?
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I am a big fan of your blog and read every post with interest (though I ve never commented). This was a great post. While inefficient distribution of resources has happened, I feel the public will anyway end up paying a high price – because the spectrum was bought by 2 firms – Unitech and Swan Telecom. Swan conveniently sold the license at a high price to Etisalat and Unitech tied with Telenor (who must have paid an equally hefty price). So the services will be priced according to the secondary sale (i.e. from license holder to actual telecom company). Of course, this is not the first example of botching up of Spectrum sale. As per Undercover Economist, NZ sold spectrum for like 10 NZ$ or so (or some equally ridiculous price) … In this case, the license has been sold and the intermediary (license holder, not the actual telecom company) has made pots of cash.
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Nice post. Why can’t we make spectrum free? Look at Wi-Fi & Bluetooth. Their popularity is mainly due to fact they use unlicensed spectrum. Because of lack of license cost for spectrum, cost of ownership (both financial and non-financial) of these devices were brought down, leading to greater adoption by manufacturers and users. And as rightly pointed out in the post, technology can make scarce resource infinite. Analogue radio and TV are inefficient in their use of spectrum and hence there was a need for spectrum allocation. But, with digital broadcast, those inefficiencies are removed and in US, FCC was able to free up spectrum.
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@An
Both WiFi and Bluetooth is meant for communication over small range for limited number of users. Spectrum is not an issue there.
@Atanu
You keep promising you will write more on something but then it never happens. But if in this case we get lucky, I will love to read your opinion on how the spectrum must be allocated so that both government and public can maximize their interests.
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Raja sold spectrum at prices that were set in 2001. The 1.76 lakh crores figure is not a figment of the media’s imagination – it is a figure that the CAG (Comptroller and Auditor General) report mentions as the loss to the exchequer. This Government auditors did their due diligence in coming out with the magic numbers in a 100-odd-page report.
If Raja did not do anything wrong, one wonders why was spectrum alloted on a first-come-first-served basis? Why were cut-off dates changed on an ad-hoc basis? Why did those firms that got alloated the spectrum sell it in a matter of a few months at 2-3 times the prices they purchased it at?What made did spectrum valuations change within a few months of their sell-off by Raja?
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There’s another issue that is not incorporated into your case study.
“Unitech paid $350-400m for its spectrum allocation, and then sold a 60% stake to Telenor of Norway for $1.3bn, making a profit of about 700% in less than a year just for owning the spectrum without any customers or experience.”
from: http://ridingtheelephant.wordpress.com/
If I read you right, you were perhaps indicating that selling the spectrum for a low amount benefited society since they had to pay low prices in the end (because the telecom’s costs were low). However, that certainly did not happen in the case of Unitech. What happened was a shift of money from customers (assuming Telenor makes up its investment via high charges) to Unitech. If Telenor fails to recoup its investment then its a transfer from Telenor to Unitech.
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the extent of the loss is mind boggling for a poor country like India!
Here goes the headlines (and even this in a liberal newspaper like Guardian generally suportive of Congress!)
India’s rulers lose £22bn in massive mobile phone scam
“India’s government was plunged into controversy yesterday with the publication of an auditor’s report into what is suspected to be India’s biggest case of state corruption.
The report by the Indian comptroller and auditor general accuses former telecoms minister Andimuthu Raja of causing a loss of about £22bn to the exchequer by failing to follow proper procedure in the award of licences to run mobile phone networks in India in 2008. The sum is unparalleled even in a country that has seen many such scandals.”
http://www.guardian.co.uk/world/2010/nov/16/india-corruption-government
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Atanu points out a fact that is largely missing from public discourse. The fact is that India has LOWEST per minute cost of cellphone use. This would not have been possible if the spectrum was sold at high price.
What about the productivity gains that economy achieved due to availability of cellphones to everyone?
What is the guarantee that if the minister had sold the spectrum at higher cost, the resulting higher money to exchequer would have been used for public good, and not stolen?? Congress is a highly corrupt party. To steal 40 billion dollars over 7 to 10 years is quite achievable by them:-)
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@ Akshar
The low-range of Wi-Fi & Bluetooth is a feature, not a bug – mainly to conserve power of mobile devices. What Wi-Fi shows is that spectrum is not a scare resource as is used to be earlier. Price of infinite resource should be zero or close to it.
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I would like to clarify a few points here.
1. Raja sold spectrum at Rs 1500 crores for a national licence in 2001. This was the same rate that the spectrum was sold in 1991. I agree that the price of the spectrum would be less than that in 2010 (Rs 1.76 lakh crores total). However, the price in 2001 is definitely not the same as the price in 1991.
2. Raja changed the rules umpteen times during the spectrum sale process to benefit certain companies and to disqualify others. One of the most obvious of those is when he gave 45 mins for the companies to come up with Rs 600 crores odd as a bank guarantee. The companies favoured by Mr Raja had already got said bank guarantee in advance of Mr Raja’s announcement.
It can be seen that Mr Raja sold off the spectrum at underpriced rates and to companies of his choosing (read companies willing to bribe him).
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@AN
When it comes to frequency there is a trade-off between coverage and number of users supported. The current GSM bands optimize both, add to that availability of devices and necessary infrastructure and it becomes a scarce resource.
People have traveled the path suggested by you. When Reliance entered telecom business they did not pay any license fee.
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Two things are possible.
Either Raja is yet another clever crook in this country or
He don’t know how to deal with this kind of scenario therefore not fit to be minister.
Circumstances tell he could be another crook who follows this:
You can be a cheat but not a fool.
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“The higher the firm’s costs, the higher the price.” Agreed.
But does the corollary that “Lower the firm’s costs, the lower the price” hold in this case? Clearly it does not, or at least it is not guaranteed. Why not give it away for free? Get rid of currency altogether and everything will be fine.
I understand that you are making a point that he might be inefficient (with a possible good intent) but may not be immoral or illegal, but thats besides the point. People will bear the costs in the end irrespective of the price at which it was sold. Just that the people are robbed of what would otherwise have been 1.7 lakh crore/ 1.7 thousand crore or whatever that number is. And the people were robbed by this idiot (may be not a crook). Is it a scam? May be not. Should he never ever hold a public office? Most definitely yes.
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The whole article is fallow. Always any public property should be sold by market decided prices. The charge is no transparency in the sale of spectrum. The article does not throw light on companies who got the spectrum, sold it immediately for an astronomical price. There is no guarantee that public will get a lower price as a end user. Coal is produced in India by huge quantity. But electricity is very costly and is not available to public. Millions of tons of rice and wheat is wasted by the government after procurement and when S Court directly for immediate distribution, our government came out and talked economics. What is that economics, people do not under stand. But one thing, many things like spectrum keep happening and it has come out to open as media found it a money making news.
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Figures like 170000 crores where it is difficult to visualize or count number of zeroes have become common these days re telecom and CWG.
For us ordinary citizens who live with limited income and watch the savings for future eroding fast, I think it hardly matters who made how much money. The hullaballois about 2G. Now we have 3G.technolog and time waits for no one. Time that we enforced some simple rules
1. Politicians have a right to take a specific cut on all contracts they approve
2. They must do it fast and take their cut from the best Company which is capable.
3. The successful Company will get back all it’s costs over specified time frame by giving the benefit of its best technology to long suffering consumers
4. The public is spared all these talks of scams and hundreds of agencies making their living doing post mortems
Jai hind
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