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