Spectrum Exhaust and the Monopolization Narrative…

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In a recent speech, outgoing FCC Chairman Julius Genachowski once again reiterated the critical importance of spectrum policy “breakthroughs” to address the “tremendous stress” on the capacity of the nation’s wireless networks “from growing digital demand.”  While Congress and regulators are doing what they can, including addressing tower siting (here and here), reallocating and sharing government spectrum (here and here), and moving forward with the voluntary incentive auctions for broadcast spectrum, these actions represent only partial (and possibly untimely) solutions to spectrum exhaust.  Addressing the problem in the near term will require secondary market transactions for spectrum, where spectrum is reassigned from lower to higher valued uses.

Unfortunately, the regulatory approval process for secondary market transactions is, in most cases, far from streamlined, as the government, the applicants’ competitors, and political interests groups regularly use the regulatory process to garner concessions that they would not otherwise be able to obtain in the normal course of business.  While the FCC has recent stepped up efforts to approve deals among smaller players relatively quickly, in deals involving the larger wireless carriers (i.e., Verizon and AT&T), central to the policy debate is the fear of some observers that the sale or transfer of spectrum to certain firms or for certain uses will result in a change in market structure which is undesirable, or what we refer to as the “monopolization narrative.”  We have seen this narrative play out in many spectrum transactions including, most recently, the proposed $1.9 billion spectrum transaction between Verizon and AT&T, where AT&T is acquiring spectrum from Verizon in the 700 MHz band.  Verizon’s entry into the secondary market for this particular spectrum is a result of its commitment to shed some spectrum resources when seeking approval of its spectrum acquisition from the cable industry in 2012.

As typically tendered, the “monopolization narrative” suffers from a profound defect.  Specifically, given spectrum exhaust, the normal rules-of-thumb about the benefits of multi-firm competition may not hold.  We provided the first theoretical analysis of this important issue in our paper entitled Wireless Competition After Spectrum Exhaust.  (See my non-technical explanation of the paper here.)  Put simply, when spectrum capacity is exhausted, it is likely that fewer—not more—firms produces lower prices and more innovation.  It’s an admittedly peculiar result to the non-economist, but the economic logic is undeniable:  i.e., when capacity is exhausted, quantity cannot rise, and if quantity cannot rise, then price cannot fall.  Other papers have found similar results using different modeling assumptions.  Given the inherent scale economy in using spectrum (that is, twice the spectrum leads to more than twice the capacity), putting more spectrum in fewer hands leads to price reductions since output can expand.

The economic implications of spectrum exhaust don’t stop there.  In a more recent Policy Paper entitled Taxation by Condition:  Spectrum Repurposing at the FCC and the Prolonging of Spectrum Exhaust, we modeled the implications of the FCC’s regulatory process wherein the agency applies value-extracting mandatory and voluntary conditions on parties to a spectrum exchange.  These conditions are essentially a form of a tax, and in that light the implications of the regulatory process are apparent.  When you tax something: (1) you get less of it; and (2) you can affect what types of transactions you get.  (You can read the CliffsNotes version of the paper in this blog.)  If resolving the spectrum exhaust is a priority for the well-being of American people and the economy, then burdening transactions with excessive and costly conditions is an unwise policy approach (and it’s certainly not a “policy breakthrough”).

In regards to the monopolization narrative, our Taxation by Condition paper offers a direct insight on the AT&T/Verizon deal.  Note first that Verizon claims it had no plans to use the spectrum in the near term, yet AT&T—who is relatively more spectrum constrained than Verizon—has plans to put the spectrum to use as soon as possible.  (According to Verizon, “the lower 700 megahertz A and B does not fit as nicely into our spectrum holdings as it may for others. So we think it is the prudent thing to do to sell these licenses off to the rest of the industry for the benefit of their customers and to enhance their ability to build out 4G LTE.”)  Thus, this deal moves spectrum from a less constrained use to a more constrained use.  In such a case, we show that the monopolization narrative is not meaningful and do so by comparing the spectrum reallocation decisions of a welfare-maximizing social planner and a profit-maximizing monopolist.

In Taxation by Condition, we show that under spectrum exhaust, a welfare-maximizing social planner will reallocate more or the same amount of spectrum than will profit-maximizing firms.  Put simply, market power does not provide an incentive to repurpose “too much” spectrum from a social perspective.  Market-based transfer decisions such as the AT&T/Verizon sale, therefore, should be presumptively welfare enhancing.  Second, the AT&T/Verizon transaction is virtually costless from a societal standpoint since the spectrum is being shifted from a carrier that was not going to put it to immediate use to a carrier that has stated it will put it to use quickly. If output continues to be constrained before and after the sale due to the existence of the industry-wide spectrum exhaust, then price will be lower with the transfer than without because the amount of capacity has increased.  The AT&T/Verizon deal, under any plausible scenario, will put downward pressure on prices.

If the goal of the FCC is to implement “policy breakthroughs” to address spectrum exhaust, then barring legitimate competitive or interference concerns, then a sensible first step is to commit to the timely and unconditioned approval of secondary market transactions that move spectrum not being currently used into the hands of entities needing to deploy it.  Perpetuating the simplistic “monopoly narrative” in the spectrum-constrained mobile communications market is not constructive.