“A government auction of spectrum effectively turned into the imposition of a £22 billion tax on the telecom industry, just when it needed all the cash it could generate in order to build new networks and compete in a global market. Such short-sightedness amplified a cyclical downturn; bankruptcies, job losses and canceled investment programmes occurred as a direct result. This undoubtedly helped to set a leading UK sector back three years”

In his book “The Undercover Economist”, Tim Harford from the FT describes the above auction, and this is how I first heard about it, having obviously missed it when it happened in 2000. You can also listen to a short programme about it on the BBC here. As a scientist, I am a geek and therefore always enjoy finding the sources for material and therefore preceded to read the background literature from the auction designers, Paul Klemperer and Ken Binmore CBE.

So did the government devise some dastardly and cunning plot to deprive the poor telecom companies of all their hard earned cash? Well, no. The economists devised an auction that was the most efficient. Efficiency, of course, being the cornerstone of the free-market that Mr Redwood is salivating for. They couldn’t of devised a more free-market auction. Mr Redwood and others blames this auction then for the problems of the industry.

True, the telecom industry did go into decline around the same time as the auction (spring/summer 2000) and some commentators have attributed this downturn to the auctions held for 3G licenses around Europe. However, this is a case of post hoc, ergo prompter hoc (thank-you West Wing), and it is particularly absurd written in a review espousing free market ideals. One quote from the time sums it up perfectly:

“If there is a problem, it is the stupidity of the bidders, not of the government”

The industry (and now the Tories) likes to blame the government for the woes of the telecom business but the fact don’t match. At the time, none of the companies thought they were getting a bad deal, in fact, obviously, as it was an auction, they thought that the price was worth paying, otherwise they didn’t have to keep bidding higher and higher. The prices were not set in advance, the companies chose to pay this price - they determined the licence’s were worth this much, no-one else. One company even sold their licence after the auction and made a profit, so they were considered good value even. The prices were also thought to spur the companies on as they would now need to recoup the money spent, so rather than inhibiting investment, they thought it would make the companies and the industry grow. The head of orange at the time said:

“In a few years, people will think that the prices we paid were conservative.”

The downturn was in fact due to the general tech downturn at the time as well as a penchant for bad acquisitions by the companies. These, combined with a competitive mobile telecom market that was starting to grow. Another argument against the auction was that the price would then be passed on to the consumer. This is an argument you hear often from companies when they are fined or when costs go up, but when you turn it on its head, the idea is nonsensical: if the licenses cost nothing, would the company then charge nothing? Prices are set by the market, they are essentially a trade off between what you and I think the product is worth.

This story might not have been what most people picked out of the ECPG review, but i think it is telling. Here, the ECPG has shown that freedom is not what they want, they just want bigger business and smaller state. The free market includes risk due to partial information, and businesses choose whether to gamble in the market or not. Here, they lost out to the state by overestimating themselves. The alternative and what presumably John Redwood & Co. would have liked to have seen would have been a beauty contest were the government picks the companies that they think will run the licenses best. This is inefficient, as then no one knows how much the licenses are really worth and the companies spend the money they save trying to lobby and lie to get the cheap licenses. This would not be the free market.