Municipal Broadband and Predatory Pricing…

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In the wake of the Federal Communication Commission’s pre-emption of state laws overseeing municipal broadband networks in North Carolina and Tennessee, I was asked by the State Government Leadership Foundation (SGLF)—a non-profit organization that helps state governments develop sound policy through education, research, and training—to conduct an economic analysis of municipal broadband to help state legislators better understand the issue.  Last month, the SGLF released the final product of my effort.  The paper is both long (nearly 70 pages) and dense, using economic theory to describe what municipal broadband is and what it is not.  I don’t wish to cover the entire content of the paper here, but note that it is fair to say that the basic economics presented in my paper prescribe a heavy dose of caution regarding municipal entry into the communications business.  Driving my analysis is the frequent claim that municipalities must deploy government-owned networks because “no one else will.”  The claim implies that such deployment will not be profitable, since it if was, the private sector would do it.  As a money-losing proposition, municipal entry necessarily requires subsidization—an uncontested fact.  Officials running these networks often contend that profit is not their objective, so the lack of it serves no barrier to their entry decision.  My analysis (and common sense) concludes that a need for subsidies and the lack of concern for profits implies these government networks are prone to be predatory in nature, pricing services below economic cost.

The predation issue is an important one—after all, predation is a violation of the antitrust laws.  While governments are often exempt from antitrust action, the Supreme Court held in City of Lafayette v. Louisiana Power & Light Company that when cities run businesses in direct competition with private companies, the cities are not exempt from prosecution.  While allegations of predation by profit-maximizing firms are generally frowned upon by antitrust authorities and experts (it is difficult to predate profitably), I found that the lack of a profit motive by government run networks introduces a different set of incentives that have yet to be fully analyzed.  I left it at that.

Shortly after the release of the paper, I received a comment from a colleague pointing out that the predation question has, in fact, been formally addressed in the economics literature.  For instance, the book by John Lott, Are Predatory Commitments Credible?  Who Should the Courts Believe?, concludes that while predation by private firms is doubtful, predation by public enterprises is plausible (see The Economist review here).  Lott’s work is largely empirical in nature, but a published paper by former FCC Chief Economist David Sappington and his co-author J. Gregory Sidak, Incentives for Anticompetitive Behavior by Public Enterprises, provides a formal, theoretical analysis of the issue.  (A companion paper by the same authors discussing Lott’s book is available here.)

The Sappington-Sidak paper provides strong support for my concerns about the predatory nature of municipal broadband.  They conclude that “public enterprise may have stronger incentives to pursue anticompetitive activities than does a private, profit-maximizing firm.  These activities include setting prices below marginal cost, raising the operating costs of existing rivals, erecting entry barrier to preclude the operation of new competitors, and circumventing regulations designed to foster competition.”  When the public enterprise considers the expansion of output as an objective, then the “public enterprise finds it optimal to pursue anticompetitive activities particularly aggressively.”  In fact, the public firm may set prices below cost on an ongoing basis, something private firms will not do.  That is, continued predatory pricing is a credible threat.

What makes the Sappington-Sidak analysis particularly well-suited for the municipal broadband issue is that the public firm is taken to pursue a variety of objectives including the expanded scale of operations.  Arguments for municipal broadband, made by city officials running such networks, is based largely on the expanded scale of operations—i.e., more deployment, more adoption—and a disregard for profit.  So, the model fits the facts.

The Sappington-Sidak papers, and a few other papers such as one by De Fraja and Delbono (1989), shed significant light on predatory behaviors, revealing how the dismissal of predatory actions by private firms does not apply to public enterprises.  Antitrust action against a city operating a municipal broadband network—perhaps overdue—would certainly be a counter to the unthoughtful policies of the Federal Communications Commission and the Obama Administration regarding government entry into the communications business.