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Spectrum auctions, spectrum liberalization and the incomplete triumph of Coase - YouTube
Channel: Marginal Revolution University
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Hi, today we're going to look
at spectrum options,
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spectrum liberalization,
and Coase's Incomplete triumph.
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Let's begin.
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The radio spectrum is that portion
of the electromagnetic spectrum
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which is particularly useful
for communications.
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Now, different frequencies in the spectrum
have different properties
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and so they're useful
for different sorts of devices.
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Lower frequencies, for example,
are able to penetrate buildings.
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So, you can listen to an AM radio
broadcast when you're inside a building,
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even if the tower broadcasting
that signal is miles away.
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On the other hand,
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if you're trying to get WiFi then you need
a new router on every floor of a building
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in order to be able to
connect to the Internet.
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Interference can reduce
the value of the spectrum.
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So the spectrum is banded both
across frequencies and over geography.
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So certain frequencies
are allocated to television,
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to radio, to cell phones,
to WiFi, and so forth.
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In addition, only one AM radio station
on a particular frequency
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is allowed in a given city,
a given geographic area.
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The banding in the United States
is illustrated in this picture
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although this is only
a very simplified representation.
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The current allocation,
this is important to understand,
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has been determined more
by history and by accident
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than by rational design
or spontaneous order.
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For example, although
it is slowly changing,
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there is still a large
fraction of the spectrum
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which is allocated to
over-the-air television broadcasts.
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Even though almost everyone
gets their television by cable,
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there's still a chunk of spectrum which
is being used for this very low-value use,
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even though this spectrum would be
much more valuable were it used,
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say, for cell phones.
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Only a tiny portion of the spectrum
has been auctioned and
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within this portion, only some of it
is actually subject to a free market.
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So, not only has the spectrum
not been rationally designed,
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only a small fraction is
subject to a spontaneous order.
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We'll talk more about that
in a few minutes.
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Let's look at the traditional
allocation of the spectrum.
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In the early history of radio,
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the Navy actually tried to
make it a government monopoly
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analogizing radio to the post office over
which the government also had a monopoly.
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That plan didn't go so far.
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Nevertheless, it was said that
government control was necessary
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because the private markets could not
or should not allocate spectrum.
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The 'could not' argument boiled down to
scarcity and interference.
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The scarcity argument is
somewhat difficult to understand
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since lots of goods are scarce.
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Lakefront property, antiques,
first editions of books, and all of these
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are very well allocated by
the market process without any problem.
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The interference problem
was more serious perhaps.
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And indeed, in the early history of radio,
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radio stations would try to
broadcast on top of one another
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and the system was somewhat chaotic.
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It was Coase, as we'll see
in a few minutes,
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who first took this problem seriously.
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The 'should not' basically
boiled down to censorship,
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not quite in this dramatic term.
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But the idea was that the public airwaves
should be used for public purposes
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to benefit, you know,
the larger community and so forth
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and not be subject to, you know,
profit and private enterprise.
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As a result of this,
the federal radio commission
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was given extensive powers
to regulate the spectrum.
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In particular, they were to prescribe
as to the citizenship, character,
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the financial, technical,
and other qualifications
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of the applicant to operate the station,
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the ownership and location
of the proposed station,
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the frequencies or wavelengths
and the power desired to be used,
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the hours of the day
the station could operate,
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the purposes for which
the station was to be used,
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and such other information
as it may require.
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In short, the FCC could award
or not award licenses
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based on public interest,
convenience or necessity.
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This was very much in contradiction
to the First Amendment
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and nothing like this would
have even been conceivable
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for something like newspapers.
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But because this was a new technology,
this contradiction was passed over.
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Not surprisingly, given these powers,
the allocation process was politicized.
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In his book on Lyndon Johnson
"The Means of Ascent"
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Robert Caro gives an example.
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So in 1943, Lady Bird Johnson,
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basically acting as a front,
bought a Texas radio station, KTBC.
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This station had been mired in red tape
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but immediately upon her buying it,
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it was allowed to operate
for 24 hours a day.
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It had been more restricted previously.
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It was allowed to move
to a better place on the frequency
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and it was allowed to
quintuple its power output.
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And it became very successful.
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Johnson would also pressure CBS to give
his radio station programming for free.
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And he would shake down local companies
to advertise on his radio station
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and later on the television stations
which he controlled.
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In the process Lyndon Johnson and Lady
Bird Johnson became multimillionaires.
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In 1959, Ronald Coase published an article
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challenging the entire
empirical and theoretical basis
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for the FCC and the government
allocation of spectrum.
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He said briefly that political pressures
resulted in misallocation of spectrum.
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And he made the point that
an administrative agency lacks the precise
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monetary measures of benefit and cost
provided by the market.
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In a very Hayekian point, he said that an
administrative agency didn't have access
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to the decentralized information
which was necessary to allocate
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spectrum as well as
other goods efficiently.
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Moreover, looking back at the 1920s
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and the chaos of radio stations
which broadcast on top of one another,
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he said that the real cause of the trouble
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was that no property rights
were created in these scarce frequencies.
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Most importantly, in 1959,
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Ronald Coase laid out very clearly
what was to become the Coase Theorem.
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It was in analyzing the radio problem
that Coase came to his great insight,
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namely that with low transaction costs
the interference problem
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that is more generally the problem
of spillovers or externalities
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can be solved by the market,
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that is it can be solved by
the assignment of property rights.
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So Coase argued
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that if property rights in a particular
portion of the spectrum were assigned,
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that even with interference,
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the property owners would bargain with
one another in order to trade those rights
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so as to maximize
the total value of the spectrum.
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He said, "the delimitation of rights is an
essential prelude to market transactions,
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but the ultimate result
which maximizes the value of production
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is independent of the legal decision."
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A very clear statement
of the Coase Theorem.
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For more on that, of course,
see our videos on the Coase Theorem.
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Not too surprisingly,
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Coase's ideas were given a poor reception
by the political process.
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In testimony in 1959,
the first question asked Coase
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was "Tell us, professor,
is this all a big joke?"
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And indeed, as we shall see,
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Coase's ideas were ignored
by the political process for decades.
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It wasn't only the politicians
who thought that Coase was wrong.
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The economists thought he was wrong too,
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even the ones who were
open to the free market
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such as at the University of Chicago.
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Coase's Theorem, Coase's argument,
challenged 40 years of accepted doctrine,
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a doctrine accepted since Pigou's work
in the 1920s on externalities.
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George Stigler called it a heresy.
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So seeking to straighten Coase out,
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Aaron Director at
the University of Chicago
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invited Coase to a dinner
along with 20 other economists.
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In attendance was Director
with Stigler, with Milton Friedman,
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economists who themselves,
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Friedman and Stigler,
later go on to win Nobel Prizes.
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Entering the dinner, it was
20 economists against Coase,
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one Coase for Coase.
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Exiting the dinner two hours later,
21 for Coase, none against Coase.
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Coase had triumphed.
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He had convinced 20 of the world's
best economists that he was right
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and 40 years of
accepted doctrine were wrong.
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That's how you win
a Nobel Prize in Economics.
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Coase had won over the economists
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but he had certainly not
won over the politicians
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who basically ignored
his ideas for decades.
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However, in the late 1970s, cellular
licenses became much more important
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and there were very long delays in
getting through the tedious FCC process.
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Instead of going to auctions, however,
the FCC went to the lotteries.
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Basically, this was a crazy system
in which anybody in the United States
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can enter the lottery to become
a cellular phone company.
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Now, of course, most of the entrants
couldn't operate a phone company
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but paper mill companies came into being,
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which simply submitted
off-the-shelf plans.
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The lottery winners were simply
hoping to win the lottery
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and then resell their rights.
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There were over 320,000 applications
for just 643 cellular licenses.
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There was a lot of rent-seeking going on,
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a lot of delays in aggregating
these licenses to the national level.
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It was a very wasteful
and unproductive system.
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Finally, in 1993, the Clinton
administration authorized auctions,
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the first of which
was held in July of 1994,
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almost four decades after Coase's paper.
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The auction was immediately successful
and raised a lot of money.
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And once the revenue
implications were seen,
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more politicians began to be in favor of
these types of auctions.
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And since July of 1994,
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the FCC has raised over 60 billion dollars
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for the US Treasury
in these kinds of auctions.
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So is this a triumph?
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Auctions were a triumph for Coase
but very much an incomplete one.
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Only a small share of the spectrum
has been auctioned
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and an even smaller share has been
auctioned with few restrictions on use.
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Most of the spectrum remains
government micromanaged,
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far more than has to be
the case or is desirable.
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Large areas of the spectrum in fact
remain underused, remain fallow.
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And revenues may even have distracted
attention from consumer surplus.
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So in their eagerness to increase
revenues for the US government,
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the auctioneers have not
paid attention to the fact
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that the real benefit of the auctions
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is getting underused spectrum,
getting spectrum which is of low value,
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moving it to the market process
where it has a much higher value,
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where it can increase consumer surplus.
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All the attention to raise revenues
may actually have
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reduced social welfare
beyond what it had to be.
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Moreover, and most importantly,
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auctions were only a small part
of Coase's liberalization idea.
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Coase said that the free market,
the invisible hand can apply to spectrum.
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And today we do not, even today, we do not
have a free market and spectrum.
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So we're still far behind
Coase's 1959 insights.
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Here are some further resources:
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of course, Coase's article,
very readable, from 1959;
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an excellent modern take, Hazlett,
Porter and Smith from 2011;
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also Hazlett and Munoz's look at
how much spectrum is not being used
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and how much consumer surplus
could still be gained
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by putting more spectrum
into the market process.
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You should also take a look
at some of our other videos
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on Coase and the Coase Theorem.
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Thanks.
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