Why exactly is connectivity so expensive in India? For instance, these days in Pune I pay Tata Indicom Rs 880 (US$20) a month for 64kbps (max) speed. Compare that to 5 years ago I used to get 256 kbps unlimited usage ADSL connectivity in Berkeley CA for only about $20 a month. One can naively ask why I don’t get 256 kpbs unlimited usage for say Rs 200 a month in Pune today?

OK, just to frame the question a little better, let me state that I recognize that prices depend on the underlying costs and on the degree of competition in the market. First, underlying costs. There are technical costs and there are statutory/regulatory/government imposed costs. Technical costs in India cannot be more than the technical costs in the rest of the world. Equipment costs approximately the same, modulo local taxes and import duties. Of course, average fixed costs vary depending on scale, and I do recognize that there are scale economies. So that is one factor that needs consideration: the scale of the operation. Perhaps the BB market is so small that some variant of average cost pricing makes the prices so high.

The non-technical costs need to be considered. First, there is licensing costs. That is a component of fixed cost. And then there are various taxes such as service taxes which add to the variable costs. If licensing costs are just what is required for funding the regulatory mechanism, then it cannot be all that high. But if licensing fees run in the several hundreds of thousands of dollars (or even millions of dollars), clearly then there is a different objective function that the government is attempting to maximize. Perhaps, and this is just a conjecture, the government is trying to maximize (short-term) revenues by imposing high licensing fees.

Just to continue along that revenue maximization line of argument, one way to extract rents is to limit competition within the market and make firms compete for the market by say auctioning the right to serve the market to the highest bidder,or just to have arbitrarily high licence fees and allow only those firms to compete within the market that successfully cross that barrier. This effectively raises the firms’ costs and therefore average cost pricing drives up the prices way above the world prices.

It appears that there is at least a limited degree of competition in the market. In Pune, I see Airtel, Reliance, Tata Indicom and BSNL in the internet access business. Their prices are remarkably similar. So unless there is collusion, their prices reflect underlying costs. It is certainly not marginal cost pricing (unless the variable taxes are extremely steep). It must be some form of average cost pricing and if so, the high average cost must reflect some high license fee because technical fixed costs (faced uniformly by all providers) cannot alone be high in India as compared to the rest of the world.

The question then so far is: what is the cost structure of the connectivity business? And how does it compare to the rest of the world.

The other matter I struggle with is: what is the objective function of the government? Short term revenue maximization? Like it attempted to do with the business of email service when it demanded outrageous license fees for the right to engage in that business, and later in the auctioning of the right to provide telephony in the various telecom circles?

If yes, then it is a very myopic policy. It hurts long-term growth of the internet in India and has serious second- and third-order impact on other sectors of the economy which could have efficiency and productivity gains from the use of the internet, such as education, commerce, and so on.