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How Not to Bring Broadband to All

August 6, 2009

Tags Free MarketsGlobal EconomyMedia and CultureInterventionismPrices

 

European politicians want to achieve broadband access for all. They think that this is a panacea and could even drive Europe out of the current economic situation. In fact, the European Commission "considers it of the greatest importance that, within the European Union, key services such as e-communications are widely available to citizens and businesses, independently of their geographical location, and at an affordable price and specified quality."[1]

Current regulation is failing to achieve this goal. So, politicians are looking for new ideas to push forward their vision for society. There is one proposal that has been in the making for some time, but which has only recently gained momentum due to the impulse of the UK government. It consists of including broadband service as part of the scope of the universal service obligations.

In the wake of liberalization, universal service obligations were introduced to safeguard the concept of reasonable access at an affordable price, irrespective of income levels and geographic location. Originally, these obligations were related to telecommunication services and, in most cases, still are.

If broadband services are considered universal service, one or more operators will be obliged to provide these services at reasonable and geographically uniform prices. In this way, the proponents think that broadband access for all will be achieved. Of course, there is no surer way of achieving the opposite effect.

The Provision of Broadband Services in the Unhampered Market

When analyzing policy options, Austrian economics begins by elucidating the operation of a free market. As Ludwig von Mises writes, "Only at a later stage, having exhausted everything which can be learned from the study of this imaginary construction, does it turn to the study of the various problems raised by interference with the market on the part of governments."[2]

In a free market, there is no imbalance between demand and supply. This means that every consumer who is ready to pay the price will be able to obtain their desired product. In a free market, there are no shortages. All demand is satisfied, and there is no need to impose an obligation of forced sales.

The price of the product tends to be the cost of production plus the going rate of profit for the capital invested.[3] If prices exceed the costs by more than this amount, there is a tendency toward expanded production and lower prices. This process is driven by entrepreneurs in search of profits.

Applied to broadband access, this implies that every consumer who values the service more than its price would be able to buy it and thus have broadband access. Because of this, the goal of extending broadband access would be accomplished. In fact, this goal is always accomplished in a free market.

Of course, the question about the affordability of the price remains. It has just been stated that the price will tend toward the cost of production plus the going rate of profit for investments. Nothing, then, can be said about its affordability in absolute terms. In fact, the affordability of the price will depend on the preferences of the individuals and their subjective valuations of the goods. What is affordable to one individual may not be so to another.

However, the market process of discovery is also at work. Market prices provide information to entrepreneurs on the valuation of resources and on the consequent opportunities for profit. The existence of profits in the broadband industry are a sign to entrepreneurs that they should drive resources toward providing broadband access in those areas where prices allow it.

As a result, new ways of providing broadband access would be discovered — for example, new technologies or new applications of existing ones — or of increasing the efficacy of its use. It is not possible to predict which new ideas the discovery market process would uncover. However, what can be said is that:

  1. It would drive down the price toward the cost of production plus the going rate of profits.

  2. It may well find cheaper ways of providing the service, thus driving down the costs of production — and, in turn, the price of the service.

Due to the law of diminishing marginal utility, a lower price for broadband access will (ceteris paribus) make it desirable to more individuals. In fact, the market process of discovery will make broadband access affordable to more and more individuals over time, achieving an increase in both the extension and affordability of the service.

In summary, a free market achieves, automatically, a universal extension of service to those users willing to pay its price. Moreover, it assures that this price will tend toward the cost of production plus the going rate of profits. Finally, it unleashes the market process of discovery, so that new technologies and uses drive down the costs of production, increase the quality and variety of the service, or do both things.

Imposing a "Reasonable" Price

However, policy makers often think that the unhampered market price is not affordable, or they grow impatient while the market process evolves. In those cases, they may be tempted to impose a presumed "affordable" price on the assumption that it will quicken the extension of the service. This is precisely the proposal of the UK government with respect to broadband access.

Of course, the first question is defining what is considered a "reasonable" or "affordable" price. As was shown above, there is no abstract, absolute level of affordability, apart from giving the service for free. What is considered affordable for some individuals — according to their particular rankings of values — is not so for others.

Thus, policy makers find themselves confronted with the insurmountable task of determining a price outside of the market. No matter what reasons are invoked to claim that the established prices are fair, reasonable, or affordable, they are always arbitrary. The only fair, nonarbitrary price in the market is the one at which both buyer and seller freely choose to make the interchange.[4]

However, this problem has proven to be of no concern for policy makers, who nevertheless come up with an "affordable" price — according to their own criteria. Once the affordable price is set, one of two things can happen:

  1. The affordable price is above the unhampered market price. In this case, there are no consequences for the market.

  2. The affordable price is below the unhampered market price. In this case, a genuine price control is in place, and the theory of price control is at work.[5]

For broadband access in Europe, the most likely outcome of intervention would be that the regulated price will be above unhampered market prices in some geographical areas and below them in other areas. This is due largely to the influence that features such as population density,[6] income levels,[7] and the nature of the territory have in affecting the cost of providing telecommunication services. This is widely recognized by the industry and its regulators.[8]

The theory of price control tells us that, in those geographic areas where the regulated price is below the unhampered market price (that is, high-cost areas), no operator will voluntarily provide the service. Instead, the government will need to impose sales obligations if it wants to stick to its original goal.

This is not enough to guarantee the desired effect — that is, that of all who demand broadband access having it at the affordable price. Demand exceeds supply, which leads to shortages in the provision for high-cost areas.

Thus, the next step would be rationing in high-cost areas. In any case, the theory of price control shows that the government must ultimately resort to central planning in order to attain broadband access at affordable prices in all geographical areas.

If the government is not willing or able to intervene further in the market, then the shortages will remain in place. Shortages under price controls disrupt production.[9] Among the consequences of shortages, the most important for broadband access would likely be the reduction of quality and service, the increase of maintenance and replacement costs, and delays in production.

There is still another effect resulting from the imposition of a "reasonable" price below market prices: the stifling of the market process of discovery. According to Kirzner's theory, regulation may inhibit desirable discovery processes which the market might have generated.[10]

Specifically, the imposition of an affordable price will restrict supply of broadband access from operators competing in other geographical areas. But not only that: it will also inhibit the discovery of wholly unknown sources of supply (like new technologies) and hinder activities as yet unforeseen. The regulated price disincentivizes entrepreneurial activity that could lead to innovative — and probably cheaper — ways of providing broadband access.

It is now clear that the imposition of broadband price affordability is incompatible with the extension of the service. Lack of profitability makes forced sales necessary — at least in high-cost areas — as the theory of price control predicts. If the government is not ready to enact central planning to support its goal, shortages will occur. Not every individual who is willing to pay the price will have access to broadband, and quality and service will suffer. Moreover, the market process of discovery will be stifled, and no entrepreneur will have the profit incentive to look for cheaper ways of providing the service, so that costs will actually remain higher than they otherwise would in a free market.

Conclusion

The only way to guarantee extension of broadband service in an efficient way is to avoid any intervention in the market. Only the free market guarantees that all demand is satisfied, and that the price is the minimum realizable without confiscating wealth from some individuals in favor of others. In addition, the free market allows the full working of the market process of discovery, which fuels dynamic efficiency, increases innovation, and can eventually lead to lower (and thus more affordable) prices.

$15 $14

 

According to the theory of price control, the imposition of affordable prices would make inevitable the imposition of forced sales for broadband access in high-cost areas. If the government is not ready to intervene continuously, shortages will develop in those areas, and the objective of extension of broadband access will be impaired.

In summary, the inclusion of broadband access in the universal service obligation will not only fail to achieve extension of broadband access, but will also fall short of the extension that would otherwise be attained under free market conditions.

But, then, what else could be expected from a government that is about to re-nationalize the telecommunication network after twenty-five years of liberalization?[11]

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Notes

[1] European Commission, Communication from the Commission to the European Parliament, The Council, The European Economic and Social Committee, and the Committee of the Regions: On the Second Periodic Review of the Scope of Universal Service in Electronic Communications Networks and Services in Accordance with Article 15 Of Directive 2002/22/EC (COM, 2008), 572 Final, Setpember 9, 2008.

[2] Ludwig von Mises, Human Action (Auburn: Ludwig von Mises Institute, 1998), p. 239.

[3] George Reisman, Capitalism (Jameson Books, 1990), ch. 6.

[4] Laurence Vance, "The Myth of the Just Price," Mises Daily, March 31, 2008.

[5] Ludwig von Mises, "Theory of Price Control," in A Critique of Interventionism (Arlington House, 1977).

[6] See, for instance, Johannes Bauer, Jung Hyun Kim, and Steven Wildman, "Broadband Uptake in OECD Countries: Policy Lessons from Comparative Statistical Analysis" (paper presented at the 31st Research Conference on Communication, Information, and Internet Policy, Arlington, Virginia, September 19–21, 2003).

[7] Kenneth Flamm, "The Role of Economics, Demographics and State Policy in Broadband Availability" (paper presented at the PURC/London Business School Conference on The Future of Broadband: Wired and Wireless, 2005, Gainesville, Florida, February 24, 2005).

[8] For example, in the recent ERG Common Position on Geographic Aspects of Market Analysis: "NRAs should also be aware that the underlying costs may (or are even likely to) differ between geographic areas and that a cost oriented price for a particular geographic area may be different than an averaged cost oriented price for a national market."

[9] For an exhaustive description of these consequences, see Reisman, ch. 7.

[10] Israel Kirzner, "The Perils of Regulation: A Market Process Approach" in Austrian Economics: A Reader, Champions of Freedom, Ludwig von Mises Lectures Series, Volume 18, ed. Richard Ebeling, (Hillsdale College Press, 1991), pp. 618–654.

[11] See Richard Wray and Ashley Seager, "'Doomsday' Plan to Renationalize BT," The Observer, February 15, 2009. For a theoretical explanation based on the theory of price control, see Fernando Herrera-Gonzalez, "Europe's Internet Troubles," Mises Daily, December 4, 2007.


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