Economic Tools for Broadband Policy
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Transcript of Economic Tools for Broadband Policy
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GEORGE S. FORDCHIEF ECONOMIST
Economic Tools for Broadband Policy
PHOENIXC E N T E R
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The 800 Pound Gorilla …
REGULATIONV.
LIMITED COMPETITION
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The 800 Pound Gorilla …
COMPLAINERSV.
IDEALOGUES
Markets Never Work Markets
Never Fail
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The 800 Pound Gorilla …
THOSE OF US WHO ARE AMAZED AT HOW RIDICULOUS THE ARGUMENTS
HAVE BECOME.
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Realistic Expectations
We need to form realistic expectations about … Market Structure (how many firms) Nature of Competition Effect of Competition on Investment and Innovation The Relationship between Communications
Infrastructure and Economic Activity The Efficacy of Regulation What Markets Do What the Data Tells Us
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Market Structure
N* is Few N ≈ 2 is not an unrealistic expectation for terrestrial, wireline
networks It appears that N ≈ 3 to 5 is right for wireless communications “Nearby” competitors (wifi, wimax) offer additional limits to
market power
COST ENTRYSIZE MARKETN *
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N*: Equilibrium Number of Firms
Firms enter until the next entrant loses money
When entry stops, and exit does not occur, we have equilibrium
N* depends on the size of the market, the fixed/sunk cost of entry, and the intensity of competition
COST ENTRYSIZE MARKETN *
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Numerical Example:Policy Paper No. 21
Number of Firms (N)
Firm Net Revenues
Entry Costs Net Profits
1 100 15 852 40 15 25
N * = 3 20 15 54 12 15 -35 8 15 -76 5 15 -107 4 15 -11
The Equilibrium Number of Firms is 3. If the 4th firm enters, all firms lose money. All make money at 3, so this is the equilibrium.
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Numerical Example:Policy Paper No. 21
Number of Firms (N)
Firm Net Revenues
Entry Costs Net Profits
1 200 15 1852 80 15 653 40 15 254 24 15 9
N* = 5 16 15 16 10 15 -57 8 15 -7
The Equilibrium Number of Firms is 5. If the 6th firm enters, all firms lose money. All make money at 5, so this is the equilibrium.
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Numerical Example:Policy Paper No. 21
Number of Firms (N)
Firm Net Revenues
Entry Costs Net Profits
1 100 5 952 40 5 353 20 5 154 12 5 75 8 5 3
N* = 6 5 5 07 4 5 -1
The Equilibrium Number of Firms is 6. If the 7th firm enters, all firms lose money. All make money at 6, so this is the equilibrium.
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Competition11
General view is the price falls as the number of firms increases
This is the Cournot View with Homogeneous Goods
Or, Bertrand with Product Differentiation
The full range of outcomes is possible theoretically
PM
MC
01 2 3 4 5
Price
N
Cournot Bertran
d
Collusion
A
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What About Competition?
Intense Price Competition
Moderate Price
Competition
Perfect Collusion
N Entry Costs
Net Rev.
Net Profit
Net Rev.
Net Profit
Net Rev.
Net Profit
1 15 100 85 100 85 100 852 15 28 13 40 25 50 353 15 12 -3 20 5 33 184 15 6 -9 12 -3 25 105 15 4 -11 8 -7 20 56 15 3 -12 5 -10 17 27 15 2 -13 4 -11 14 -1
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Competition and N
There’s a Difference: Intensity of Competition Number of Firms
The Intensity of Competition relates to how firms interact
Price reductions from additional firms is based on more firms competing, not necessarily a change in the way they behave with respect to price
Intensity is behavior, not count, and too much intensity leads to very few firms
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The Evidence
Can we form a general expectation about the intensity of rivalry?
Empirical studies are mixed
Experimental work suggests the tendency is Cournot or better.
Experimental Results:Fouraker and Siegal
(1963)Type Outcomes
Collusion 3Weak
Competition1
Cournot 7Bertrand 5
Total 1675% were Cournot or Better.
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More Like Cournot More Like Bertrand
Price is inversely related to industry concentration P = f(HHI) P = f(N)
Price is not related to industry concentration for 3 or more firms P≠f(HHI) P≠f(N) Price cut occurs at 2nd firm. Difficult to distinguish
between Cournot with only 2 firms.
Also difficult to differentiate when N gets large
Interpreting the Evidence
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Too Much Competition?
Policy Paper No. 24: Network Neutrality and Industry Structure Argument: If differentiation is prohibited by rule,
firms are homogeneous, leaving only price to compete over.
Intense price competition can deter entry, leaving monopoly and no price competition at all.
Paradox Differentiation softens price competition, but allows
for price competition.
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What’s the Benchmark?N* = 2
17Perfect Competition
Marginal Cost = MCFive Firms
P5
Equilibrium Industry Structure P2 is as low as it goes Profit ≈ 0 N=3, Profit < 0
PM
P2
P5
MC
0 1 2 3 4 5
Price
N
Cournot
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What’s the Benchmark?N* = 2
18Perfect Competition
Marginal Cost = MC Profits = 0
Marginal Cost Pricing Not Possible Losses = abcd
Equilibrium Industry Structure Can only satisfy zero
profit condition with fixed/sunk costs
MC Pricing not possible without massive subsidies
P2
MC
0
$
q
Firm Demand
Avg. Cost
ab
cd
EquilibriumN=2
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The 800 Pound Gorilla …
REGULATIONV.
LIMITED COMPETITION
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Competition and Investment/Innovation
Investment and Innovation are higher with competition, up to a point
Effect 1. Monopolies have the profits to fund innovation, but face no pressure to do so.
Effect 2. Competition reduces profits, but firms innovate to escape competition (create market power).
Rat
e of
Inn
ovat
ion
Competition
Maximum
*Aghion et al, Competition, Imitation and Growth with Step-by-Step Innovation, Review of Economic Studies (2001).
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Efficacy of Regulation(and it’s role)
How good is regulation in a Monopoly setting?How good is regulation in a Duopoly setting?How good is regulation in a Triopoly setting?And so forth?Is limited competition better than regulation?What can regulation improve in a setting of
limited competition?What the role of regulation if we have N* and
its small?What N* = 2, Profit = 0, yet there is collusion?
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Congress’ View:The Cable Act of 92
1992 Cable Act deregulated a cable system when it had a competitor that passed 50% of its market (and had a penetration rate of at least 15%). Deregulate at 1.5 firms
Small systems were also unregulated Benefits < Costs
Unbundling/Special Access Triggers (a bit nutty)
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Successes and Failures
Cable Regulation – Failure Special Access – Failure Unbundling – Failure Interconnection Reform – Failure USF – Broken? Broadband Ubiquity by 2007 – Failure Payphone Compensation – Repeated Failure Wireless E911 - Failure
Madison River?
Part 68 Rules – Success (Monopoly Period) Number portability wireline, wireless, but not between – Success E911, Wireline and VOIP, not wireless – Success Spectrum Auctions – Success Other ….
How do we pick successful interventions?
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Special Access Profit Margins
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
Pricing Flexibility/Deregulation
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Madison River
VOIP-Capable DSL = $30VOIP-Blocked DSL = $20FCC Says No VOIP-Blocking, or No Price
DifferencesVOIP-Capable DSL = $25 (or something like
that) Now everyone pays $25, where many would prefer to
pay $20Under plausible conditions, such a decision is
welfare reducing (consumer welfare reducing!)
Difference is opportunity cost of lost profit from phone service.
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Regulation versus Limited Competition
A little competition probably wins this battle.Regulation is typically for things that the market
cannot fix (Externalities, Natural Monopoly, Social Programs).
Price and Quality are the purview of the market. Firms can impede competition
Perfection is not possible by regulators or markets, because perfection is subjective. Firms typically meet the average needs (cost-benefit test) Some Won’t be Happy
Who’s driving policy today?
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Be Realistic About Markets
Markets don’t resolve problems in an instant It is the loss of a large number of customers that reveals a
bad business decision. That takes time. Complaints and news articles are the manifestation of this
emigration. It is often evidence the market is working, not failing.
There will be complaints – people complain incessantly about Wal-Mart. Some people complain about their Toyota or Honda, despite being highly reliable, affordable autos. Complaining is not evidence of market failure. Service prices and quality YOU or I don’t like is not market
failure.
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Be Realistic About Markets
Home Networking Network Neutrality proponents use as example Market eventually solved it without regulation
Bluetooth Crippling Another Net Neutrality example Market solved it
WIFI Crippling Another Net Neutrality example Market solved it
Firms are out for profits, so expect manifestations of that. But consumers are out for the best deal, and expect that discipline. Watch for long-term problems.
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A REVIEW OF BROADBAND COMPARISONS AND RANKINGS
What About the Evidence?
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Broadband Rankings, OECD
2001 2002 2003 2004 2005 2006
Korea Korea Korea Korea Iceland Denmark
Canada Canada Canada Denmark Korea Netherlands
Sweden Belgium Iceland Netherlands Netherlands Iceland
U.S. Iceland Denmark Iceland Denmark Korea
Demark Netherlands Canada Switzerland Switzerland
Sweden Belgium Switzerland Finland Norway
Netherlands Sweden Belgium Norway Finland
U.S. Japan Japan Canada Sweden
Switzerland Finland Sweden Canada
U.S. Norway Belgium Belgium
Sweden Japan UK
U.S. UK Luxembourg
U.S. France
Japan
U.S.
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Broadband Rankings
What should ourbroadband ranking
be?
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Broadband Rankings
What are the policy ramifications of
our rank?
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Broadband Rankings, OECD
2001 2002 2003 2004 2005 2006
Korea Korea Korea Korea Iceland Denmark
Canada Canada Canada Denmark Korea Netherlands
Sweden Belgium Iceland Netherlands Netherlands Iceland
U.S. Iceland Denmark Iceland Denmark Korea
Demark Netherlands Canada Switzerland Switzerland
Sweden Belgium Switzerland Finland Norway
Netherlands Sweden Belgium Norway Finland
U.S. Japan Japan Canada Sweden
Switzerland Finland Sweden Canada
U.S. Norway Belgium Belgium
Sweden Japan UK
U.S. UK Luxembourg
U.S. France
Japan
U.S.
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Normalization of Subscription Counts
OECD ranks subscriptions per capita
Per Capita is a reasonable choice for normalization, but it is not an innocuous adjustment.
Any adjustment introduces error; may not make much of a difference, but it may.
Home A: 4 peopleHome B: 3 peopleIf both have a
broadband, then Home A has a subscription rate of 25 while Home B has a subscription rate of 33.
Household normalization helps, but does not control for businesses.
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United States Sweden
Persons per Home = 2.7
Persons per Home = 2.0
Normalization
The U.S. needs 35% more connections than Sweden to make up the
difference.
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2006 Broadband
Ranking
2003 Telephones
RankingDenmark Luxembourg
Netherlands SwedenIceland IcelandKorea Norway
Switzerland DenmarkNorway SwitzerlandFinland FinlandSweden GreeceCanada UKBelgium Italy
UK GermanyLuxembourg Netherlands
France SpainJapan Czech Republic
Some countries tend to rank high in per-capita communications consumption.
The U.S. presently ranks 24th in telephone per capita (wireless and wireline).
Over the period 1991-1998, we ranked about 7th.
After 1998, the U.S. has fallen to quickly to the low 20’s (presumably due to mobile phones and different counting schemes).
Who ranks high?
High Rank for Communications
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Broadband Rankings, OECD
2001 2002 2003 2004 2005 2006
Korea Korea Korea Korea Iceland Denmark
Canada Canada Canada Denmark Korea Netherlands
Sweden Belgium Iceland Netherlands Netherlands Iceland
U.S. Iceland Denmark Iceland Denmark Korea
Demark Netherlands Canada Switzerland Switzerland
Sweden Belgium Switzerland Finland Norway
Netherlands Sweden Belgium Norway Finland
U.S. Japan Japan Canada Sweden
Switzerland Finland Sweden Canada
U.S. Norway Belgium Belgium
Sweden Japan UK
U.S. UK Luxembourg
U.S. France
Japan
U.S.
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Time and Subscription
Time
SubscriptionRate
Measure
At Time t0
Measure
At Time t1
A fall in rank may suggest leadership.
Must have some guesstimate of terminal subscription for rank to relevant.
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Household Penetration of Broadband:US and EU OECD Members
Norway
Denmar
k
Finlan
d
Belgium
Swed
en UK
Franc
e
Luxe
mbour
g
German
y
Austri
a
Polan
d
Hunga
ry
Portu
gal
Czech
Italy
Irelan
d
Slova
kia US0
10
20
30
40
50
60
70Household Penetra...
Source: EU Commission, E-Communications Household Survey (Apr. 2007). U.S. from Pew Internet and American Life Project (2007).
Complaint: Different studies/methodologies. But, where does the OECD data come from?
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Broadband Nirvana:All Homes and Business Have Broadband
Country Subscription Rank Country Subscription Rank
Sweden 54.1% 1 Norway 40.3% 16
Iceland 48.9% 2 New Zealand 39.8% 17
Czech Republic 47.8% 3 Portugal 39.2% 18
Denmark 47.8% 4 Japan 39.0% 19
Finland 47.7% 5 United Kingdom 38.9% 20
Germany 44.9% 6 United States 38.0% 21
Netherlands 43.7% 7 Luxembourg 37.8% 22
Australia 31.5% 8 Greece 36.2% 23
Switzerland 42.9% 9 Slovak Republic 35.1% 24
France 42.4% 10 Ireland 34.7% 25
Canada 41.9% 11 Poland 34.1% 26
Hungary 41.1% 12 Spain 33.8% 27
Belgium 41.% 13 Korea 25.4% 28
Austria 40.6% 14 Mexico 24.7% 29
Italy 40.4% 15 Turkey 21.2% 30
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Determinants of Broadband Subscription
The Broadband Nirvana ignores the impact of income, age, density, and so forth on subscription.
PHOENIX CENTER POLICY PAPER NO. 29 measures the impact of a wide range of determinants of broadband subscription to assess whether or not countries are exceeding, meeting, or falling short of “expectations.”
Relevant determinants are: Price (-), Income (+), Income inequality (-), Education (+), Age (-), Density (+), Phones (+), Business Size (-), Time (+).
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Algebra: y = a + bx
Econometrics: Regression
Regression Analysis
25
20
15
10
5
0 1 2 3 4 5
y
x
y = 30 – 5x
25
20
15
10
5
0 1 2 3 4 5
y
x
We try to fit the
curve to “messier” data
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Univariate Regressiony = a + bx
Multivariate Regression:y = a + bx + cz
Regression Analysis
25
20
15
10
5
0 1 2 3 4 5
y
x
25
20
15
10
5
0 1 2 3 4 5
y
x
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Effect Size of Determinants
Variable Effect for a 10% Increase
Variable Explanatory Power
GINI -8.4% AGE65 50
GDPCAP +8.1% GDPCAP 42
AGE65 -7.3% BUSSIZE 41
BUSSIZE -3.5% DENSITY 31
PHONE +2.5% GINI 30
PRICE -2.3% PHONE 20
EDUC +1.8% PRICE 18
DENSITY +0.8% PHONE2 18
BIGCITY -0.6% EDUC 13
HHSIZE +0.4% BIGCITY 04
HHSIZE 00
AGE65 Japan = 26.9% AGE65 Korea = 12.4%
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Broadband Policy
90% of differences in broadband subscription across OECD is explained by non-policy factors
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Broadband Performance Index(Alternative Specification)
Exceeds Expectations
Below ExpectationsMeets Expectations
Gre
ece
(28)
Irel
and
(23)
Slov
ak R
ep. (
27)
Luxe
mbo
urg
(12)
Cze
ch R
ep. (
25)
New
Zea
land
(21)
Pola
nd (2
6)
Ger
man
y (1
8)
Mex
ico
(30)
Ital
y (2
0)
Swed
en (8
)
Aust
ralia
(16)
Japa
n (1
4)
Nor
way
(6)
S. K
orea
(4)
US
(15)
Spai
n (1
9)
Can
ada
(9)
Fran
ce (1
3)
Den
mar
k (1
)
Net
herl
ands
(2)
UK
(11)
Turk
ey (2
9)
Hun
gary
(24)
Switz
erla
nd (5
)
Aust
ria
(17)
Finl
and
(7)
Bel
gium
(10)
Port
ugal
(22)
Icel
and
(3)
-4.00
-3.00
-2.00
-1.00
0.00
1.00
2.00
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What Should We Rank?
Estimate the BPI regression only for the top 15 of OECD countries excluding the U.S. Coefficients are driven by the most successful
countriesU.S. Ranks 10th
Absent reformulations of the counting schemes across countries (like for wireless), the U.S. should rank about 10th in subscriptions per capita This is roughly consistent with its rank for
telephones/pop before wireless
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From Rank to …
The rank statistics often precedes claims about Lack of deployment Lack of Bandwidth/Speed
Ubiquitous availability might move us up 4 spots in the rankings Assuming 10% unavailability, we go from a
subscription rate of 0.196 to 0.218. Assuming 5% unavailability, we go up 3 spots.
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Does Speed Matter?
Higher speeds will only draw in the marginal users
Those that want speed the most have already subscribed to broadband
Speed is unlikely to increase our broadband ranking, or reduce it
Speed Value A Value B1 40 52 50 103 60 154 70 205 80 256 90 307 100 358 110 40
At $30, the high-value customer buys broadband at any speed. Speed must be 6Mbps for the low-value customers to buy. POINT: Higher speeds impact only marginal users.
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Speed and Subscription:No Help Here
Speed
SubscriptionRate
After about here, the additional impact of speed on subscription is trivial.
For OECD countries, advertised speeds (provided
by ITIF) are unrelated to broadband subscription rates in a well specified
model.
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Speed and Time
Time
Speed/Technology
•Technology improves over time.
•Investments are made at time t.
•Network remains for x years.
•Later investments are in better technology.
•Perpetual game of catch-up or leap frog.Invest
Use
Invest
Use
Are we paying the price for being a first mover?
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Time and Subscription
Time
SubscriptionRate
Measure
At Time t0
Measure
At Time t1
A fall in rank may suggest leadership.
Must have some guesstimate of terminal subscription for rank to relevant.
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The Demand for Bandwidth: Korea (KTT)
Service Up Down % SubsLite 640Kpbs 4Mpbs 84%
Premium 4Mpbs 13Mpbs 4%Special 4Mpbs 20Mpbs 5%Ntopia 4Mpbs 50Mpbs 12%
Source: S. Wallsten, Progress on Point 14.13 (June 2007).
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Broadband Speeds
Country Claimed Speed (Mbps)
Actual Speed(Mbps)
Japan 61.0 12.0Korea 45.6 3.4
Finland 21.7 3.6Sweden 18.2 7.4France 17.6 4.7
Netherlands 8.8 5.0Portugal 8.1 3.1Canada 7.6 3.6Poland 7.5 1.6
U.S. 4.8 4.7
Sources: Claimed Speed, D. Correa, ITIF (2007). Actual Speed, www.speedtest.net (2007); Korea may be slightly understated due to a lack of a local test server. Sample sizes in Speedtest.net data are often very large.
Of actual speeds, U.S. ranks 8th of 100 countries.
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The Japanese Miracle?
Japan is touted as a “broadband miracle” Claim: 100 Mbps Fiber Service for $30
Reality Avg. Download Speed = 10Mbps 100Mbps = $53/month Japan is ranked 14th in OECD, basically with the same
subscription rate as U.S. 58% DSL; 29% Fiber; 14% Cable
Zero and Low Interest Loans for NetworksTax Incentives (not very important with 0% loans)33% of Municipal System Construction Costs are
SubsidizedIs it unbundling or zero-interest loans?
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Investments in Broadband
K = Investment Amountr = Hurdle RateP = Price you can sell it for (price structure)c = incremental costn = number of buyersI = Information availableQ = Quality of ServiceZ = Other stuff like income, education, etc…
K(1 + r) ≤ (P-c).n(P,I,Q,Z)56
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Investments in Bandwidth
Cost of the upgrade must exceed the net revenue from the sale of the services made possible.
If you upgrade your network to 50Mbps, how many people will buy it?
Communications carriers can only spend what investors will give them. Investors demand a return. That’s the world we live in.
If you don’t reward investors, the money won’t come.
Cost≤ Benefit
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Investments in Bandwidth
"It is not the multitude of alehouses … that occasions a general disposition to drunkenness among the common people; but that dis-position, arising from other causes, necessarily gives employment to a multitude of alehouses."Adam Smith, Wealth of Nations
(1776)
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Investment in Bandwidth
MARKETS DON’T WORK That depends on what you want markets to do. Rather than saying the market has failed to provide
adequate speed and coverage, why not say the market is providing us information that the demand for speed is low and the demand is inadequate to cover costs in some markets. A proper perspective leads to proper policy responses
Markets work because they are the fastest way to disseminate and incorporate information. Look to the market as a source of information. An all-knowing being could mimic the market (but I’m not
interested in the job).
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Investments in Broadband
K = Investment Amountr = Hurdle RateP = Price you can sell it for (price structure)c = incremental costn = number of buyersI = Information availableQ = Quality of ServiceZ = Other stuff like income, education, etc…
K(1 + r) ≤ (P-c).n(P,I,Q,Z)60
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Investments in Broadband
Action EffectPrice Regulation Probably Less InvestmentNet Neutrality Probably Less InvestmentTax Incentives More Investment
Low Interest Loans More InvestmentSubsidies More Investment (if done right)
Connect Kentucky More InvestmentMore Competition Depends (up or down slope?)
K(1 + r) ≤ (P-c).n(P,I,Q,Z)61
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Firms Invest Less than Society Desires(Complaints are to be expected)
Private Decision: K(1 + r) ≤ (P-c).n(P,I,Q,Z)
Social Decision: K(1 + r*) ≤ (P-c).n(P,I,Q,Z) where = ratio of 1 plus the Avg. Consumer Surplus per unit relative to profit and r* ≤ r.
Interestingly, charges different prices to different people/groups reduces the difference.
Regulatory risk inflates r. FCC says competition inflates r.
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[PRELIMINARY]BPI FOR U.S. STATES
What about the US?
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Effect Size of Determinants
Variable Effect for a 10% Increase
Variable Explanatory Power
INSCHOOL -22.0% RURALFARM 0.57
NATIVE -20.0% NATIVE 0.40
GINI -13.2% RURAL 0.37
HHSIZE -12.8% GINI 0.36
ENGLISH +8.7% ENGLISH 0.34
RETIRE -3.4% HHSIZE 0.14
PERCAPINC +3.3% RETIRE 0.12
SELF EMP. +2.6% SELF EMP. 0.11
RURAL -2.3% INSCHOOL 0.08
EDUC +2.1% PERCAPINC 0.08
BUSSIZE +1.5% BUSSIZE 0.06
RURALFARM -1.4% EDUC 0.05
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BPI – Sort of(Preliminary)
Mississ
ippi
Colora
do
Arka
nsas
Washin
gton
Delawar
e
Penn
sylva
nia
Wyoming
New M
exico
Wiscon
sin
Minnes
ota
Orego
n
Verm
ont
Califor
nia
Montan
a
New Yor
kOhio
Nevad
a
Rhode
Islan
d
Conne
cticu
t
Distric
t of C
olumbia Utah
Louis
iana
Kentuc
ky
New H
amps
hire
Georg
ia
-4.95
-3.3
-1.65
0
1.65
3.3
4.95
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