Discretionary public policy - the case of 2G spectrum allocations

This post will be provocative. I have a simplified interpretation of India's controversial 2G telecoms spectrum allocation process.

The fundamental issue is that the government of the day decided to allocate the spectrum without any competitive price discovery process, and subsequent events (spectrum resales by a few purchasers) point to the allotment having been made at a steep discount thereby causing huge losses to the public exchequer. In simple terms, the spectrum was sold cheap, and private spectrum purchasers benefitted at the expense of the tax payers.

Critics of the allotment process claim that if the spectrum was auctioned off, as happened with the subsequent 3G auctions, the government would have raised huge amounts. The bidders would have paid close to the actual cost of the spectrum. There would have been no corruption. So what gives?

Here is a thought experiment. I can imagine two forces that were generated by the low spectrum prices.

1. The substantial discounts enabled the telecom operators to keep their initial fixed investments low. They now had resources to spend on technology and more importantly, aggressive expansion. Furthermore, it gave all players the initial cushion to establish the market, without having to over-charge. Such over-pricing is a characteristic feature of any nascent market, as the first generation of firms try to establish themselves. It generally takes time before the market stabilizes and the firms start responding to market competition signals.

2. It cannot be denied that the lower spectrum prices dramatically reduced entry barriers and contributed towards creating an intensely competitive marketplace. The threshold cost to enter the market was lowered. In simple terms, the government subsidized the private operators significantly.

As the private operators got established, the market stabilized, customer base exploded, these two aforementioned factors interacted to generate fierce competition. This competition benefited the customers and the market itself.

Consider the counterfactual. Assume the spectrum was allocated by auctions. It is most certain (especially given the information asymmetry in a new market) that the process would have been affected by "winner's curse", whereby bidders would have quoted a premium on the fair market value. The successful operators would have entered the market with strained balance sheets and limited inclination to be aggressive in their investments and pricing. Instead of spectacular explosion, the market would have grown in fits and starts. Most certainly the government would have had to intervene subsequently to prop up the market with various types of fiscal concessions.

The central point I want to make is that the discounted allocations provided the operators with the required cushion to be aggressive and innovative in a nascent market. This in turn helped lay the foundation for a very competitive and vibrant telecoms market in India. The aforementioned dynamics is true of any emerging market. China is the best and most recent exemplar of the wastage, excesses, and corruption that lubricates such emerging markets.

In any typical emerging market, governments provide considerable fiscal support, directly and indirectly. In its absence, the only way in which a market can emerge is if large foreign competitors, with deep-pockets and a commitment to take sustained losses for some time, enter the market.

Much of this support is not planned and is a response to problems posed by emergent difficulties in the growth process of the particular sector. In fact, there is considerable corruption (sanitized through lobbying which conceals an equally nauseating underbelly of quid-pro-quos) involved in these policy decisions. It would be interesting if we could compare the fiscal support given to sunrise sectors like IT and biotechnology with that given to the mobile telecom sector.

The critical governance question here should be about the extent of malafide discretion involved in the allotment process. The acrimonious post-mortem has revealed that the government, or influential people within the government, played an important role in picking winners and enriching themselves at the cost of the public exchequer. It is this market failure that should be the cause for the greatest concern.

This also raises another question. If auctions would have led the market into a low-level equilibrium and discretionary allotments spawned massive corruption, what is the alternative? What process of allotment would have given the participants with the required cushion and allowed the market to develop fast without causing incentive distortions that spawn corruption? I am not sure there is any such process.

This brings us back to the inevitability, even desirability, of discretionary public policy, espcially in incubating new markets. In the circumstances, the focus should be on minimizing corruption in the discretionary public policy making space.