Economists get it wrong often enough that our smugness is pardonable when events prove us right. This week’s news that the Canadian government got some $4.2 billion by auctioning rights to use radio frequencies for the next generation of cell phones affords such vindication. It also raises the policy issue of why we don’t use auctions when selling other government assets, especially the right to mine on federal lands.
It’s easy to become blase about large numbers, but $4.2 billion is a large sum for Canada, with only 33 million people. The same per capita amount would add up to $40 billion in the United States. That is twice our most recent auction, of the 700 megahertz spectrum, which brought in just $19.6 billion earlier this year.
There’s a certain justice in Canada administering this lucrative auction. It was Canadian-born economist William Vickery whose early work on auction theory got the whole ball rolling 47 years ago.
For decades, governments in most countries handed out rights to use radio frequencies. In practice, that often meant political favoritism played a major role. When Lyndon Johnson was in Congress, he and his wife were able to build a significant broadcasting business by wielding his political clout.
As new frequencies became scarcer, the Federal Communications Commission moved to holding hearings to determine the most worthy applicants and tried lotteries. But it never charged more than nominal fees.
While the government doled out licenses gratis, the number was limited enough that they became highly valuable. The FCC license was a major factor in determining the price at which a radio or TV station sold. The right to broadcast on a particular frequency obviously had great value.
Legally, such rights originally belonged to the nation as a whole, just like oil, gas or minerals under federal lands. Some economists argued that if a valuable public asset was to be given to private entities, it should be auctioned off to the highest bidder, just as oil and gas leases are. Congress and FCC bureaucrats pooh-poohed the idea.
In the 1980s, however, new technology facilitated tighter control of frequencies, allowing more stations to be packed into a given range of the frequency spectrum.
At the same time, new devices like pagers (remember those?), cell phones and personal digital assistants increased the need for more assignable frequencies.
It took a long time for officials to pay attention to economists. President George H.W. Bush proposed frequency auctions in his budget submission to Congress in 1990, but it wasn’t until 1994 that the FCC actually held an auction. The $650 million in winning bids opened congressional eyes. The rest is history, with nations around the world adopting auctions not only to sell frequency licenses, but also to privatize state-owned companies in Latin America.
Vickery worked on the theory of auctions in general, not on the specifics of frequency auctions. But his work suggested the design of the auction was critical. For example, he found that an auction in which the highest bidder gets the object being sold, but only has to pay the price bid by the second-highest bidder, actually raises more money than a simple auction in which the high bidder has to pay the price he actually bid.
Vickery found that multiple-round auctions, in which initial bids were announced and then bidders given the right to revise their bids, were most efficient in revealing bidders’ true willingness to pay for the object offered.
The FCC and frequency managers in other countries adopted Vickery’s idea. The first FCC auction was spread over four days. The Canadian auction that ended Tuesday had started May 27. Bidders such as Verizon (which won a block of frequencies earlier this year for $4.7 billion) hire math Ph.D.s to design complex game-theory models to guide their bids.
So if we can get tens of billions of dollars for the right to use cell phone or TV frequencies, many now ask why we still give out the right to mine federal lands for a minimal filing fee. The General Mining Act allowing such giveaways dates to 1872. But it remains politically popular in western states, where free minerals are thought to translate into high-paying jobs. When the Republicans controlled Congress, influential red-state senators blocked any changes. Now that Democrats are in control, that remains true. Senate Majority Leader Harry Reid of Nevada is the son of a miner and has made it clear our government will continue to give away valuable mineral rights as long as he has anything to say about it.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.