The relationship between regulation and investment is important because investment is important.  Private investment drives the economy, and private investment in broadband facilities is expected to have a particularly potent effect on economic growth.  In the current economic environment of high unemployment, investment is also important because it often (but not always) creates jobs.  In a recent paper, we showed that private investment has a sizeable effect on job creation in the macro economy, particularly when the economic growth is slow.  In another paper, we estimated that each million dollars invested in the ICT sector produces 10 jobs in that sector and perhaps another 12 jobs throughout the rest of the economy (for a total of 22 jobs per million invested).  And, of course, with investment in modern broadband infrastructure, we get other important societal benefits including, as we have shown,  the reduction of depression among the elderly or keeping unemployed people from becoming “discouraged” and leaving the workforce altogether.

With high unemployment, politicians certainly want to claim their policies promote investment and, consequently, jobs.  Take, for example, a recent statement by Federal Communications Commission Chairman Julius Genachowski, who claimed that investment in the U.S. wireless sector “is responsible for creating 1.5 million U.S. jobs in recent years.”  While the Chairman no doubt wants to share in the credit, assessing the FCC’s influence on investment, or any administration’s influence for that matter, requires a counterfactual analysis.  It is not enough to say that investment is up, or down, or that such-and-such investment created such-and-such jobs.  The relevant issue is what influence a particular regulatory agenda has on investment incentives relative to a different and perhaps less-regulatory agenda.  In what direction is regulation trending?  In that regard, the relevant question is whether firms expect future regulation to be more or less favorable to making profits from large-scale, sunk investments.

While regulators are often loath to lay down the details of a particular agenda, lest they be boxed in, the process of regulatory decisionmaking often exposes a tendency.  In some cases, these patterns are explicit.  Take, for example, the statement of former FCC Chairman William Kennard,

… with competition and deregulation as our touchstones, the FCC has taken a hands-off, deregulatory approach to the broadband market. … We need an intentional restraint born of humility.  Humility that we can’t predict where this market is going.  Indeed, who among us could have predicted the incredible advances of the past few years?  Who at the beginning of this decade could have predicted the embrace of e-mail by all ages, the birth of the World Wide Web, the advances in communications technology?

Of course, anyone could make such a statement, regardless of their policies.  But Chairman Kennard put his money where his mouth was, further noting,

We approved the AT&T-TCI deal without imposing conditions that they open their network.  We did this because there is no sign that as this nascent market matures that the cable operator has an incentive to deny ISPs access to their platform.  There is no sign that consumers do not have other avenues to get broadband connections if they don’t want to use cable.  And finally, it is not clear that the perceived benefits of mandating open access outweigh their apparent economic and technological costs.

These statements sent a bold signal to broadband service providers that the FCC did not intend to over-regulate their networks.  The agency, going forward, “will [let] a competitive marketplace thrive.”

Contrast Mr. Kennard’s approach with the signals sent by the current FCC.  In the Open Internet Rules, for example, the FCC’s willingness to regulate broadband networks did “not depend upon broadband providers having market power with respect to end users,” and that the regulations were not intended “to prevent[] only those practices that are demonstrably anticompetitive or harmful to consumers.” Competition, in other words, is not enough to avoid regulation, and behavior that is beneficial to consumers is not enough to avoid regulation.  The current FCC’s signal is obvious—it will be the policy of the agency to use the heavy-hand of regulation on broadband networks regardless of the circumstances.

In our Broadband Credibility Gap paper we published two years ago, we detailed a few of the instances of the current Administration’s regulatory proclivities in the broadband arena.  Since that time, the agency has continued to careen down the path of more regulation, with much of it being direct or indirect price controls.  Let’s look at just a few examples:

First and foremost, we have the FCC’s Open Internet Rules.  Like it or not, such rules are unambiguously price regulation, because broadband service providers (“BSPs”) are specifically prohibited from charging a positive price to content firms (e.g., Netflix), even though these services impose the greatest costs on the network.  Instead, BSPs are forced to recover these costs directly from the consumer; an alternative we have demonstrated may make us all worse off.  Just because the regulated rate is “zero” does not imply that regulation is harmless.  Larry went into great detail about this very point in a blog post dated January 31, 2012, which I commend for your reading pleasure.

Equally as important, the FCC in the Open Internet Order made it clear it was willing to sabotage the investments in the wireless industry made under one set of rules by threatening to change the rules in the future.  Indeed, despite the fact that wireless carriers had spent billions on unencumbered spectrum licenses, the FCC explicitly stated it could encumber that spectrum whenever it wished to do so:

Even after licenses are awarded, the Commission may change the license terms “if in the judgment of the Commission such action will promote the public interest, convenience, and necessity.” The Commission may exercise this authority on a license-by-license basis or through a rulemaking, even if the affected licenses were awarded at auction. (Open Internet Order at ¶ 133 and citations omitted.)

More troubling was the fact that the Commission appeared to dismiss out of hand the argument that changing the rules post-auction would violate the contractual nature of the auction.  According to the Commission, the agency,

retains the statutory authority to impose new requirements on existing licenses beyond those that were in place at the time of grant, whether the licenses were assigned by auction or by other means.  (Id. at ¶ 135, citations omitted).

In other words, the FCC made it abundantly clear to all investors, and did so in a setting where such threats were entirely unnecessary, that is has the authority to sabotage sunk investments at will.  Economic theory makes it clear that such threats diminish investment incentives.

Let’s continue and consider the FCC’s attempt to create a homogenous cable set-top box by issuing a Notice of Inquiry to create a new “AllVid” paradigm.  As we demonstrated, given the economics of the problem, the AllVid paradigm—like the CableCard paradigm before it—is doomed to fail.  If anything, the Commission should seek to sunset the statute pursuant to the provisions of Section 629.  Rather than taking the opportunity to encourage investment by sunsetting an outdated regulatory idea, however, the Commission continues to hang the possibility of AllVid over the industry like a sword of Damocles.

Then we have the FCC’s infamous Phoenix Forbearance Order.  The 1996 Telecommunications Act was supposed to be “pro-competitive” and “deregulatory.”  As we demonstrated in great detail, however, the standard for forbearance set in the Phoenix Order effectively renders Section 10 of the Act moot by establishing a forbearance threshold—price equals marginal cost—that is impossible to satisfy in most (if not all) communications markets.  (For those interested in exploring this issue further, I presented this paper at our 2010 Symposium and the video may be viewed here.)

More recently, we have the FCC’s Data Roaming Order, where if parties cannot come to an agreement, the Commission will arbitrate and subjectively decide what is “commercially reasonable” using no less than SEVENTEEN different factors.  As Larry explained in his January 31, 2012 blog post, however, the clear bias contained in the Data Roaming Order cannot but help to prejudice negotiations.  In Paragraph 79 of the Data Roaming Order, the Commission outlines its review process as follows:

… if negotiations fail to produce a mutually acceptable set of terms and conditions, including rates, the Commission staff may require parties to submit on a confidential basis their final offers, including price, in the form of a proposed data roaming contract. These submissions would enable Commission [to order] the parties to enter into a data roaming agreement pursuant to the terms of the complainant’s [] final offer.

Given the explicit bias of the agency (to the complainant), those companies seeking roaming agreements will surely shave their best offers by a significant amount.  Again, despite the fact that the Chairman’s Office described this order as a “lighter touch approach”, the Data Roaming Order unambiguously imposes price regulation on the wireless industry and, in doing so, chooses a biased regulatory approach threatening those making investments in favor of those trying to avoid them.

Finally, we have the FCC’s recent Notice of Proposed Rulemaking to promote interoperability in the 700 MHz band.  While Larry went into great detail about the “fishyness” of the FCC’s logic behind that NPRM in a blog post dated March 28, 2012, more germane to this blog post is the following quote from the Commission:

… if the industry fails to move timely toward interoperability once interference concerns are adequately addressed (by regulatory action or otherwise), additional regulatory steps might be appropriate to further the public interest.  (Id. at ¶ 49.)

And what would this regulation be?  The FCC would require licensees “to use only mobile user equipment that has the capability to operate across all of these blocks.” (Id. at ¶ 50.)  Again, the agency explicitly presents the threat of heavy-handed and costly solutions by threatening to mandate the type of equipment a firm must use.  Such heavy-handed interventions are a consistent theme of the Genachowski administration, and perhaps his legacy.

To paraphrase Section 706 of the Communications Act, the FCC is supposed to “encourage the deployment” of advanced telecommunications capability to all Americans by “remov[ing] barriers to infrastructure investment.”  Yet, at present, perhaps the greatest deterrent to infrastructure investment is this FCC’s persistent threats of heavy-handed regulatory interventions in a market that is performing well by most standards.  Given this FCC’s legacy of heavy-handed regulation, I would recommend that broadband investment not be one of the Obama Administration’s central talking points during the upcoming election cycle.

Most notably, holding a hearing at this stage of the review process sends a chilling message to the staff at both the FCC and DOJ that Congress does not trust them to do their jobs.  As a former senior staffer myself, I can tell you that while the daunting task of conducting an honest and rigorous review of complex transactions is hard enough, living with the constant specter that anything I may do might incur the immediate wrath of some powerful Congressmen makes your job outright impossible.  Similarly, if the political appointees who actually run the reviewing agencies are convinced that politics and not substance will govern the process, then why should they expect substantive comments from stakeholders?

Moreover, in order to conduct a serious analysis of a transaction of this sort, you need the cooperation of the industry as part of this process.  For this reason, the U.S. government has set up elaborate legal safeguards to ensure that any proprietary information submitted as part of the review process will be kept confidential.  As Capitol Hill tends to leak like a sieve, this proprietary material, by design, typically is not shared with Congress.  So, unless Congress would like to subpoena and analyze the same information—thus wasting taxpayer dollars by rendering the DOJ/FCC review process redundant and moot—it is unclear what politicians with imperfect information can substantively add to the discussion.  After all, isn’t the whole point of establishing the DOJ and FCC to bring some subject matter expertise to the review process?

To his credit, Connecticut Senator (and, prior to that, long-time Connecticut Attorney General) Richard Blumenthal recently echoed many of these very points at an oversight hearing of the Verizon/Spectrum Co. transaction in an interesting colloquy with former Reagan Administration Antitrust Chief Charles “Rick” Rule:

Senator Blumenthal:  But a full evaluation of this deal would really depend on an examination of those kinds of material, that kind of information, testimony, interviews, documents, all of the stuff that you review as an antitrust enforcer, that the FCC could review in evaluating motive, purpose, effect, and so forth, even though many of these documents and those materials are not available to this subcommittee.

Mr. Rule:  That is correct. And, again, my experience both being somebody who has represented companies that had to spend a lot of money to sort of respond to that, but, also, being at the government, is that they are very thorough and I trust that they will be very thorough here.

And I think it’s pretty clear the kinds of things they’ll want to look at. I think they’ll also get their economists involved, because as I mentioned in my testimony, two of the more interesting filings are the competing declarations of the economists, Judith Chevalier, I guess, for the opponents and Michael Katz for the companies. And the government will engage in that and probably look at a lot of data.

But, again, I have a lot of confidence that they’ll do a thorough job.

Senator Blumenthal:  And the reasons that those documents are not available to the committee would be the proprietary information that they include or—as now a private antitrust lawyer, maybe you could explain that.

Mr. Rule:  Sure. A lot of the documents that the government gets are highly confidential. The Hart-Scott-Rodino Act, in the wisdom of Congress, limits significantly the use to which the government can put the information and to whom they can disclose it.

Senator Blumenthal:  And part of the reasons excuse me for interrupting is, very simple, Hart-Scott-Rodino review occurs before the transaction actually goes forward so that it can be stopped before the eggs have to be unscrambled, so to speak.

Mr. Rule:  Correct. And the thought was in the 1970s when the Act was passed, because it has turned out to be very common to all of us, at the time, it was kind of a radical idea, but the notion was that if businesses were going to be subjected to those kinds of investigations, that really has to go to the most sensitive, competitively sensitive confidential information in order to answer the questions that you’ve raised, that the government had to guarantee the confidentiality of that material.

And that’s why it’s so limited in terms of who the government can disclose it to. I’m sure they’d love to disclose it to this committee and others.  That sometimes would make their lives easier.  But the fact is the law prevents them from doing that.

Senator Blumenthal:  Thank you very much.  Thank you, Mr. Chairman.

So where does this leave us?  As noted above, Congress can hold a hearing on anything they deem relevant at any time they want.  Certainly, Congress has that power.  The question, like everything else in Washington, is timing, tone and topic—that is, how is power exercised responsibly?  For example, having Congress review and, if necessary clarify, the FCC’s public interest authority to review license transfers is completely appropriate and welcome.   This is precisely the point of Chairman Greg Walden’s recent FCC reform bill.  However, absent evidence of malfeasance on behalf of the FCC or DOJ, Representative Waxman’s and Eshoo’s call for a hearing while a fact-specific investigation is ongoing is nothing more than political kabuki theater.

Right now, we have two expert agencies evaluating the Verizon/Spectrum Co. transaction, directing their trained and credentialed experts in the law and economics of acquisitions and communications to pour over the massive amounts of detailed, confidential and often technical information related to the deal.  As we have demonstrated in prior research and blog posts, evaluating the competitive effects of such transactions is particularly complex given spectrum exhaust.  Given the simple fact that Congress set up the transaction review system firms currently operate under in the first instance, we should let that process play out without adding political fat to the fire.  Pressuring the referees in the middle of the game to affect the outcome is simply not good government.

This weekend, Steven Crowley at GigaOm, a consulting engineer, posted some comments on our paper.  He describes the paper as “some fresh, thought-provoking thinking on mobile competition analysis,” but then challenges the idea there is spectrum exhaust. For three reasons, I think it is appropriate to respond to Steven’s commentary:  (1) Steven is a credentialed and prolific consulting engineer focused on mobile wireless technology; (2) Steven took the time to actually read our paper and provide written comments; and (3) a response provides an opportunity to offer some clarifications to our analysis which may make it more compelling.

First, let’s review what our paper said.  In Wireless Competition After Spectrum Exhaust, we appended to the basic Cournot Model of competition (which finds that more competitors leads to lower prices) an industry-shared resource (e.g., spectrum) that could effectively constrain the capacity of the Cournot competitors.  We also assumed that there was a type of “scale economy” in this shared resource, so that doubling the amount of spectrum a firm had more than doubled its capacity.  We demonstrated that if the capacity-constraint was binding (i.e., a “spectrum crunch” or “spectrum exhaust”), then the standard more-firms/lower-price outcome of the Cournot Model was no longer valid.  In fact, fewer firms led to lower prices!  Given that the FCC contends there is a spectrum shortage, yet it also depends heavily on the standard Cournot result that more competitors leads to lower prices (see, e.g., its CMRS Reports and its review of the AT&T-T-Mobile merger), it’s plain that this result is of significant policy relevance, forcing (we hope) the FCC to rethink its competitive model for the industry.

With this review in mind, let’s turn to Steven’s commentary.

Most of what Steven says about our paper is based on his belief that spectrum exhaust is not a problem because of “trends in the mobile network architecture that intended [sic] to address the capacity crunch.”  Steven goes on to state that “[o]ne concern I have with the study … is the need for there to be a condition of ‘spectrum exhaust’ for the model to work.”  To begin with, Steven’s assessment of our model is technically incorrect.  Our model encompasses the case of both a binding and non-binding spectrum constraint (as just described).   That is, the model “works” whether the constraint is binding or not.  In fairness, I think Steven’s point is that the Cournot result is not “turned on its head” in the absence of a binding constraint, but we make this point clear in our paper.  Indeed, that’s what makes the paper interesting—the constraint matters, and it matters a lot.

As detailed in the paper, my blog post, and above, absent spectrum exhaust, our paper admittedly offers nothing new, and perhaps this is the point Steven is trying to make.  But even if you don’t believe there is exhaust (either now or in the near future), we believe it is worth keeping one thing in mind—the White House, the FCC, Congress and much of the industry are all operating on the assumption that currently allocated spectrum resources are inadequate to continue supporting the volume of consumer demand (both now and especially in the future).  Consequently, it is important to model spectrum exhaust in order to fully understand its implications, since the exhaust mindset is driving policy and investments.

Let’s turn now to why Steven is unconcerned about spectrum exhaust.  First, he argues that capacity is not simply a function of the amount of spectrum.  He is correct.  A finite quantity of spectrum can yield greater capacity using, for example, “increased antenna sectorization at the base station.”  It is well documented that the companies clamoring for more spectrum are also deploying interim technical solutions to extract more capacity from existing allocations.  However, this reality doesn’t materially affect the findings in our paper; either the constraint is binding or it is not.  If sectorization removes the constraint, then the standard Cournot result applies (at least in theory).  Keep in mind, however, that sectorization is not a costless way to increase capacity, and consumers must eventually bear all costs.  The costs for additional infrastructure deployment and other tools to extract more capacity from existing supplies may be so high as to be non-economic.  There is a FCC study on this very issue (though I suppose Steven might take it to task, as would I on some issues).  Moreover, as I understand it, most RF engineers agree that even with interim steps to do more with existing supplies, commercial wireless networks will simply need more raw spectrum to support the expected demand for more wireless broadband.  In fact, Steven has a number of blog posts related to finding more spectrum for U.S. carriers (which I would take to be a waste of time if there was no capacity issue).

Steven also argues that the capacity of spectrum can be increased using “Wi-Fi and small-cell offloading.”  However, these options do nothing to increase the capacity of spectrum, they merely shift traffic from one network to another (that is, offloading targets demand rather than fundamentally altering supply, unlike sectorization which targets supply).  Further, the point ignores the reality of Wi-Fi hot spots themselves becoming overwhelmed with traffic and becoming a less viable solution for consumers. In contrast to Steven’s argument, I believe offloading is good evidence that spectrum exhaust is a reality today.  Otherwise, why would carriers bother?

A few comments in Steven’s blog suggest a bit of clarification on our behalf is perhaps needed.  First, Steven states that we “present a model that happens to show two [wireless competitors] as optimal.”  This is not the case.  Steven’s statement is based on Figure 1 in the paper where we illustrate graphically the relationships between price and quantity and industry concentration both with and without a binding capacity constraint.  We stated in the paper that the figure was based on purely arbitrary assumptions that were required to convert the theory into something that could be illustrated in a graph.  Perhaps we did a poor job of making that clear enough (though Steven quotes the relevant text).  Steven correctly notes that, “a different set of assumptions, equally arbitrary, could indicate a higher or lower number than two”—this is correct and the essence of arbitrary parameter selection.  So, while Steven points to an article suggesting a “Rule of Three,” and also suggests that “[m]aybe two, as shown in the Phoenix Center model, isn’t that far off,” if it turns out that two is optimal, we unfortunately can’t claim foresight.

Steven also discusses the example used in my blog post to explain the “scale economies” assumption in spectrum.  The example reads,

“Say you have 100 MHz of spectrum and you divide it among 4 firms so that each gets 25 MHz. Say this generates 100 units of capacity. If instead you divided 100 MHz among two firms, so that each gets 50 MHz, then the amount of total capacity would be something like 150.”

Steven then asks, “Why 150 instead of, say, 105 or 200? We aren’t told.”  The reason “we aren’t told” is that it doesn’t matter.   It’s a numerical example designed to illustrate a technical point.  As for the theory, as long as there is some “scale economy” in spectrum holdings, no matter how small, you get the same result (note that the size of the price response depends on the size of the scale effect, but size is an empirical question, not a theoretical one).

Steven offers a number of other but less substantive comments on the paper.  For example, he argues that some of the Wall Street analyst reports we cite in the paper regarding “too much competition” are more than two years old.  We note that the theme of excess competition in mobile wireless sector is a current one.  An excellent “live” discussion of the topic with respected industry analysts at our 2011 Symposium is available on our website (second video; and watch the first video, at 1.04, for my presentation of the Spectum Exhaust paper).  Steven also didn’t care for us citing the FCC’s technical report on spectrum exhaust, which he has taken to task on his blog.  As the analysis was targeted at FCC policies, we view using the FCC’s own documents to support the agency’s claims on spectrum shortages was sensible.  If you don’t like the report, there is other evidence about spectrum exhaust from reputable engineering sources, industry and financial analysts, and, most notably, the recent expenditure of huge political capital from both the White House to virtually every segment of the wireless industry to help pass legislation that gives the FCC the authority to hold voluntary incentive auctions for broadcast spectrum.  Whether or not exhaust is a reality or a fabrication is a debate that likely will continue, and while we tend to side with the reality crowd, we respect the rights of those who believe otherwise.

Finally, we must respectfully disagree with Steven’s statement that our “analysis, in its present form, is [not] ripe for influencing policy.”  To the contrary, spectrum exhaust, whether a reality or a fabrication, is a key driver of federal communications policy and industry investments, and likely will be for the foreseeable future.  Besides, we are confident the paper is already influencing policy.

We appreciate Steven taking the time to review our study and providing some insightful comments and suggestions.  Such dialogue among industry professionals is essential to good policy.  I hope this conservation moves the ball forward.

Also, for those interested in the economics of this problem, Professor Luke Froeb, an economist at the Vanderbilt Department of Mathematics, pointed me to a couple of his papers (here and here) that reach similar conclusions in entirely different contexts using entirely different methodologies.

The agency’s rulemaking appears to be motivated by the desire to promote handset availability for the smaller and rural operators that purchased A block licenses in the 2008 auction.  According to these carriers, given their given their small size they cannot obtain the same advanced handsets as can the larger carriers.  However, so their argument goes, if all the handsets can operate across the entire lower 700 MHz band, then handset innovation is socialized across all carriers using that band.  Without this equipment—which following the argument means without interoperability mandates—the smaller carriers claim they cannot afford to build out their networks.  As such, the A block will lay fallow.

Let’s get this straight:  At the time the licenses for the reclaimed lower 700 MHz band were sold in Auction 73 (2008), there was no interoperability requirement on that spectrum.  However, most of the A block was purchased, at a price tag of about $4 billion, by the very same small and rural carriers who now are asking the FCC to impose interoperability requirements on the lower 700 MHz band.  So if I understand this correctly, these carriers are essentially now conceding that they willingly and knowingly entered into the auction without a viable business plan, but yet they would now very much like the FCC to provide them with one post-auction via mandated interoperability.

If this argument smells fishy, it is because it is fishy.  Of course, that never gets in the way of poor public policy from the FCC.  When reading the FCC’s Interoperability NPRM you’ll see the agency contemplating two potential outcomes:  (1) no interoperability and a potentially diminished use of the A block; or (2) interoperability with an enhanced use of the A block countered by a potential for interference (which the FCC has already pooh-pooh’d in the NPRM) and other unintended ills (which the FCC always minimizes).

To these outcomes, I propose a third alternative:  no interoperability, take the spectrum back from those carriers that fail to meet their buildout requirements (which they claim today they cannot meet), and put the valuable spectrum into the hands of wireless firms that want to and can use it to expand coverage and capacity to support more wireless broadband.  Spectrum is too scarce a resource to give it to those that require so much coddling.

Indeed, when viewing the issue in this light, I am reminded of a 2011 report by CITI analysts Jason Bazinet and Michael Rollins entitled Wireless Supply and Demand.  In this report, the authors conclude that, inter alia, the government has allocated “[t]oo much spectrum [to] companies that are not planning on rolling out services or face business and financial challenges,” and that the shortfalls in spectrum (and capacity) could be curtailed by allowing incumbent carriers to “acquire more underutilized spectrum.”  In my opinion, CITI’s conclusion about the allocation of scare spectrum resources is on point:  perhaps we need to move spectrum to those who can best use it, rather than promulgate inefficient and costly regulations simply to prop up otherwise uneconomic business models.

As it turns out, we looked at this very issue last year in a paper entitled Can Government Spending Get America Working Again? An Empirical Investigation.  Rather than contemplate the average or typical effect of government spending on private-sector jobs as many of the studies in this field typically do, we divided the past fifty years of U.S. economic history into low-growth and high-growth periods.  We then applied a non-linear, two-regime model to study whether the stimulus effects of government and private investment differ between recessionary and expansionary periods.

And guess what?  During periods of economic sluggishness (such as the current situation), we found that government spending has zero effect on private-sector job creation.  This result is consistent with the apparent impotence of huge federal government spending increases aimed at reducing unemployment.  In contrast, when it comes to job growth, expansions in private investment are effective in both regimes, but its efficacy is greatest during economic stagnation.  By implication, policies that discourage private investment may have more severe job-killing effects during economic downturns, since it is during the low growth periods that private investment is most effective at creating jobs.

To illustrate this point, we calculated the employment effects of a hypothetical 5% increase in private investment (about $90 billion in 2005 dollars) and the equivalent dollar increase in government spending.  As set forth in Table 2 from our paper below, based on the computed multipliers, an additional 432,000 jobs would accompany this 5% increase in private investment during the low-growth period.  In contrast, an equivalent $90 billion increase in spending by the government would produce no net jobs in the low-growth period.  For the high-growth periods, however, the $90 billion in government spending or private investment both would generate over 200,000 jobs.  Be sure to note the significant increase in the potency of private investment in the low-growth regime (another 432,000 jobs) relative to the high-growth regime (just over 200,000 jobs).  This differential effect is informally consistent with the idea that periods of higher growth are coincident with higher levels of resource utilization, so increases in demands may involve displacement and price rises to a greater degree.  Other explanations are also possible.

The results from our two-regime non-linear model are important for policymakers.  First, government spending does not appear to be an effective stimulant for private-sector job creation during periods of slow economic growth.  As such, the federal government simply can’t spend the U.S. out of high private-sector unemployment.  Second, private investment has a positive effect on job creation during low and high growth regimes, but the jobs effect is more potent effect during periods of low growth.  Based on the historical data, therefore, stimulating private investment, not more government “stimulus” spending, appears to be the key to labor market recovery in the current economic environment.

We are not alone in our assessment of the government’s inability to stimulate private sector jobs.  In a recent paper (January 2012), Professor Valerie Ramey (University of California, San Diego), a leading researcher in the area of government spending and economic activity, presented econometric evidence regarding the response of job creation to shocks in government spending.  Using a variety of econometric models and datasets, Professor Ramey summarizes her findings as follows: “I find that increases in government spending lower unemployment.  Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment.  I thus conclude that on balance government spending does not appear to stimulate private activity.”  (Emphasis supplied.)  Therefore, despite using different techniques and different samples than our own analysis, Professor Ramey’s analysis and our paper reach the same conclusion—government stimulus cannot be counted on to increase private sector employment.

Accordingly, in light of these results and the evident failure of government stimulus to restore economic growth, job creation appears best served, under present economic conditions, by policies that encourage efficient private-sector investment.  By most accounts, including President Obama’s, this means at minimum reform of the nation’s regulatory bureaucracy.

While the FCC’s analytical approach to merger analysis has often left much to be desired, from a procedural standpoint perhaps the biggest issue of concern for lawmakers has been the massive proliferation of so-called “voluntary” commitments that are often wholly unrelated to the transaction under consideration.  These coerced “commitments” over the years have ranged from the shamelessly political (e.g., backroom deals to provide heavily subsidized Internet service or new buildout requirements to high cost areas) to “big ticket” policy items (e.g., a “de facto” spectrum cap in the Harbinger Order; special access and other wholesale commitments in the Qwest/CenturyLink merger; commitments made by Comcast in its acquisition to buy NBCUniversal to abide by the FCC’s Open Internet Rules even if such rules are thrown out in court).

Now, let me be quite clear here:  if there is a merger-related harm, then the Communications Act makes it clear that the Commission has the authority to impose a narrowly-tailored condition to remedy this harm so long as those conditions are consistent with applicable law.  However, if a “voluntary” commitment has absolutely no nexus to any merger-related harm and is instead nothing more than an attempt by the Commission to achieve a policy objective by adjudication that it could not otherwise implement by rulemaking, then that is a different animal altogether.  Indeed, as Tom and I argued, given the complexity and economic impact of the type of “voluntary” merger commitments we have seen over the last few years, fundamental due process demands that these issues deserve to be vetted in an industry-wide rulemaking with public notice and comment rather than negotiated behind closed doors with a few select parties—particularly when you are talking about “big ticket” generic policy items like net neutrality, spectrum caps, or special access regulation.

This is why I am so pleased to see the House Energy and Commerce Committee make an effort to put a stop to this nonsense.  Today, the Committee is marking up H.R. 3309, the “Federal Communications Commission Process Reform Act.”  Under Section 13(j)(1) of the proposed bill entitled ‘‘Transaction Review Standards”, the “Commission shall condition its approval of a transfer of lines, a transfer of licenses, or any other transaction under section 214, 309, or 310 or any other provision of this Act only if”—

(A)     the imposed condition is narrowly tailored to remedy a harm that arises as a direct result of the specific transfer or specific transaction that this Act empowers the Commission to review; and

(B)     the Commission could impose a similar requirement under the authority of a specific provision of law other than a provision empowering the Commission to review a transfer of lines, a transfer of licenses, or other transaction.

While regulatory reform is far more complex than most people realize and is always fraught with the specter of unintended consequences, these simple provisions designed to minimize the (unfortunate) politicization of the FCC’s merger review process is a welcome start.  As such, regardless of what you may think of the overall FCC process reform bill, this common sense solution to ensure procedural due process and “good government” deserves bi-partisan support.

Not unexpectedly, the political interest groups went berserk at the news, claiming that these were exactly the type of arrangements the network neutrality rules were designed to block.  Could it be, however, that such pricing arrangements are good for consumers, good for content developers, and good for the network operators?  A win-win-win?  The answer is YES.

We asked this very question five years ago and provided the answer in a Policy Paper entitled Network Neutrality and Foreclosing Market Exchange: A Transaction Cost Analysis, first released in March 2007 and then academically-published in 2009.  In that paper, we modeled the issue from a multi-sided market, transactions cost perspective.  For the set up, we had many content providers providing services to many consumers via a broadband intermediary—a two sided market with the broadband provider in the middle.  We wanted to evaluate the effects of a rule that prohibited the broadband providers from charging a positive price to the content providers—a rule often associated with network neutrality and, in fact, a rule included in the FCC’s Open Internet Order.  To create a relevant scenario, we assumed that in addition to the broadband provider selling connections to the end-users, it could also sell an enhanced “bump” in service to permit the sale of content needed prioritization or enhanced speed (say a video or ball game).  A key feature of the model is the assumption that the costs of setting up the enhancement are lower for the content provider relative to the end user.  For example, it is cheaper for Amazon.com to set up shipping for its sales than it would be for the consumer to do so on their own.  This modeling choice can be interpreted quite generally and encompasses a wide range of potential arrangements.

Using this setup, we derive the equilibrium prices for content and broadband services both in an unregulated state and under a rule where only the end-user could be charged for the enhancement (that is, the Open Internet Order’s rule).  Our model reveals that rules that prohibit efficient commercial transactions between content and broadband service providers could, in fact, be bad for all participants.  To begin with, under the prohibition consumers would pay higher prices for both broadband service and content.  These higher prices result in less broadband adoption, and the price affects all broadband customers, not just those that want to purchase the enhancement.  Under the law of demand, higher broadband prices mean lower broadband adoption, which is plainly contrary to the stated policy goals of the U.S. government.  Also, higher content prices mean fewer content purchases.  Fewer purchases, in turn, are likely to lead to fewer content providers, given the nature of costs in that business.  Furthermore, if the broadband provider is also a content provider, the regulation shifts sales to the broadband provider’s affiliate.  Sounds like a nightmare—but one induced not by free market exchange, but by regulations aimed at stopping it.

Opponents of innovation in the pricing of broadband capacity claim that such innovation harms consumers and reduces content, but our analysis shows this need not be correct.  Indeed, such prohibitions may in fact be the root cause of undesirable outcomes—higher prices to consumers, fewer content providers, and the shifting of business to the content affiliate of a broadband provider.

The network neutrality regulations recently set by the FCC prohibit for wireline networks the arrangements now being proposed by content firms for mobile networks.   Now the political interests groups will certainly step up their already existing efforts to extend such regulations to the mobile networks.   As we all know, the content firms were instrumental in the development of the Internet regulations, and it appears they now may be defending themselves against those very rules.  After writing our paper, I was convinced that eventually it would be the very content providers that supported network neutrality regulations that would become the most vocal opponents of the regulations.  It appears that I’m about to find out if that’s true.

While the implementation of the specific provisions of such ambitious legislation will no doubt be complex and arduous, I would like to touch on two general themes in this particular post.

First, we at the Phoenix Center are very proud that our research helped contribute to get the D Block assigned to public safety so that our first responders can finally have the nationwide, interoperable broadband network they deserve.  (For example, a video of House Committee on Homeland Security Chairman Peter King introducing our research as the lead pieced of evidence into the record may be viewed here: http://www.youtube.com/watch?feature=player_embedded&v=K9kMzh12v3c).  Indeed, not only did we demonstrate that giving the D Block to public safety would save taxpayers money over the long run, but that many of the parochial arguments made to deny our first responders this crucial spectrum made little legal or economic sense.  While spectrum policy can, at times, become quite cynical, we salute both the Congress and President Obama for resisting the temptation to auction off the D Block and doing what our research indicated was the right thing.

Our second observation about the new legislation is that the fight over who gets any new spectrum will remain front and center for the foreseeable future.  Indeed, while Section 6404 of the new legislation specifically states that while the Commission cannot prevent a person from bidding so long as that person meets all of the general eligibility requirements, “Nothing … affects any authority the Commission has to adopt and enforce rules of general applicability, including rules concerning spectrum aggregation that promote competition.’’

Stated another way, spectrum caps may be back.  The big policy question, however, is whether this is a good thing?

The argument for spectrum caps is as straight forward as it is naïve:  spectrum caps can be used to increase the number of wireless competitors by limiting how much spectrum any one firm can use.  As stated by Greg Rosston, former FCC Deputy Chief Economist and, more recently, Senior Economist for Transitions at the FCC:

… the FCC has tools to make facilities-based competition more likely and more viable.  First and foremost, the FCC should get even more spectrum out into the marketplace.  And it is probably important that the spectrum not continue to go into the hands of the two incumbent landline telephone companies that also have by far the most valuable wireless spectrum.

If only it were that simple.  The problem with such arguments is that they rest on the assumption that the equilibrium number of firms serving the wireless industry is determined solely by spectrum holdings, and that the quality of services does not depend on spectrum holdings.  Obviously, neither assumption is true.  Spectrum is but one input into the production of wireless services—given a firm spectrum does not ensure its financial success (as we have seen, repeatedly).   Moreover, the more spectrum a firm has the more advanced services it can provide.  The tradeoffs in regard to spectrum allocation are described in our recent paper A Policy Framework for Spectrum Allocation in Mobile Communications, published in the Federal Communications Law Journal.  You can see George’s summary of the paper at this blog post.

It is also interesting to look at the history of spectrum allocation and market shares.  As demonstrated by the figure from our Spectrum Allocation paper below, the amount of spectrum has risen, yet industry concentration, as measured by the concentration ratio, has not declined.  Thus, historical evidence does not support the notion that “more spectrum” automatically means “more firms.”  Second, while concentration has risen over this interval, the price of mobile telephony has fallen consistently over the period.  Therefore, historical evidence also does not support the notion that higher concentration leads to higher prices.

The issue of spectrum allocation becomes even gnarlier when you incorporate the problem of spectrum exhaust.  As we show in our recent paper Wireless Competition Under Spectrum Exhaust, if, as the FCC argues, wireless firms face a binding spectrum constraint, then increasing the number of competitors will actually increase prices, increase congestion and reduce quality.  With spectrum exhaust, the standard view that more competitors leads to lower prices is turned on it head.  George summarizes the analytics of this paper here.

We have done much research on the issue of spectrum allocation, and these studies are highly relevant to the efficacy of spectrum caps.  We hope that our efforts are helpful to conscientious policy makers, and will continue to address the issue of spectrum allocation in future research.  Certainly, spectrum caps are on the table, and likely as a main course.  We shall see how this debate plays out over the coming months and years.

In his opening statement, Committee Chairman Greg Walden noted that “Last year, the FCC was given a budget of $424.8 million, and the FCC has reported that it can maintain current services with a budget of $421.2 million.  Although that’s less than a one percent decrease, it’s a start, and I appreciate the work of the FCC to keep costs down.”

While, as former FCC staffers ourselves, we certainly have empathy for our hard working colleagues in the agency, given both our growing deficit spending and our still-stagnant economy, is a less than 1% reduction in the agency’s total budget—particularly as the Commission is ostensibly removing many outdated regulations in the face of the competitive realities of the market—really the best we can do?

We think not.  And for two reasons.

First, President Obama’s proposed budget for 2012 adds another $1.3 trillion to the nation’s national debt.  The federal government is still living well beyond its means, and much of what the FCC is doing these days we could perhaps do without.

Second, last spring, we released a paper entitled Regulatory Expenditures, Economic Growth and Jobs: An Empirical Study.  In this paper, we show, using fifty years of data and advanced econometric techniques, that there is a demonstrable link between the size of the total regulatory bureaucracy and jobs and GDP.  Indeed, the data indicate that just a 5% across the board cut to all federal regulatory agency operating budgets would produce $75 billion in new GDP growth and create 1.2 million new private sector jobs EACH YEAR.

We even break these findings down into a “cost per regulator.”  According to our study, each year, a Federal Regulatory Agency Employee:

• Cuts GDP by $6,200,000;
• Eliminates 98 Private‐Sector Jobs; and
• Destroys the Equivalent of the Economic Output of 134 Persons.

In terms of an employment multiplier, each million dollar increase in the overall federal regulatory budget costs the economy 420 private sector jobs each year.

While the data do not permit us to do an agency-by-agency breakdown (e.g., the cost to the economy of the FCC’s regulations versus the costs of EPA or SEC or FERC regulations), as Congress and the President struggle with the difficult decisions of how to shrink federal spending and how to grow the economy, our paper demonstrates that a sensible place to start would be to investigate responsible cuts in the budgets of federal regulatory agencies—including the Federal Communications Commission—of more than 1%.

In response, Congress is working on a partial solution to the impending shortfall, including authorizing the FCC to conduct an auction in which broadcasters voluntarily transfer their spectrum to broadband service providers.  Chairman Genachowski, however, has expressed displeasure with the bill.  Why?  The Chairman has publicly stated he is not in favor of the bill because it would require the FCC to refrain from influencing auction outcomes by manipulating who can participate in the auction.

There are many, no doubt, that think the proposed limits on FCC discretion as reflected in the House bill are largely aimed at Mr. Genachowski, who plainly has strong regulatory proclivities.  I made a case for that view in an earlier blog.  In all fairness, however, the need for legislative limits on FCC discretion in auction participation rules need not rely solely on the agency’s recent regulatory activities.

To begin, let’s look at the record of Mr. Genachowski’s mentor:  former FCC Chairman Reed Hundt (particularly as Mr. Hundt has participated actively in the current legislative debate against any Congressional auction restrictions).  Mr. Hundt was responsible for the first “C Block” fiasco, where the FCC set aside valuable spectrum for “designated entities”, and excluded otherwise qualified companies from bidding.  As many of these “designated entitles” lacked the financial wherewithal to pay for the spectrum (much less have the additional cash necessary to build-out and manage a wireless network), over half of the 493 licenses from that auction were later returned to the government for non-payment, and the licenses of the largest winner, NextWave, were tied up in bankruptcy litigation for years.  In that case, the FCC’s use of its “discretion” ended up costing the U.S. Treasury billions, and left vitally needed spectrum unused for years.  Legislation blocking such social-engineering non-sense would clearly have been in the national interest.

Interestingly, there was also a second “C Block” fiasco.  When it came time for former FCC Chairman Kevin Martin to auction the prime spectrum freed up by the digital television transition, the Chairman encumbered (apparently at Google’s urging) a large block of spectrum with “open network” rules.  And guess what?  These open access obligations imposed upon on the Upper C block in the 700 MHz auction cost approximately $3.1 billion in lost auction revenues, or about a 40% loss in auction revenue relative to an unencumbered license.  What were the benefits of such encumbrances?  Zero (except for Verizon, who picked up the spectrum at a substantial discount).  Again, discretion was costly, and legislation impeding such activity would have been socially beneficial.

It doesn’t end here, sadly.  Past FCC manipulations of auctions have left spectrum assigned for public safety purposes fallow for years, and our nation’s first responders are still without a modern, interoperable public safety network.  And there’s the AWS-III debacle, where the FCC proposed that 25% of the capacity of this national license be devoted to a free broadband Internet access service, complete with a mandatory “’always on’ network-based filtering mechanism” for adult content.

So what can we learn from these examples?  At the most basic level, we can see that the FCC’s past meddling with spectrum auctions has produced a string of expensive failures.  As such, there is good reason to believe that when spectrum is auctioned off cleanly without any encumbrances, society is likely to be better off.  Without question, there is no affirmative case for meddling.  Accordingly, having Congress limit the FCC’s ability to impose its world view on the industry via the spectrum auction is sensible public policy.