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’ 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 19the 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.]