In introductory economics we are often reminded that the strong presumption in favour of markets stems not from the fact that they always work perfectly (they never do), but because the alternative is usually worse. Therefore, assigning 3G spectrum, a scarce resource, through market-driven auctions is far superior to other methods, such as comparative hearings or “beauty contests" and lotteries. So, the move towards auctioning 3G spectrum is a good one, though it took fairly long in coming.

It will introduce transparency in a system that has been riddled with controversy—recent media reports have been full of recriminations in the previous allocation of 2G spectrum to the incumbent service providers. In fact, almost all major service providers have benefited from some favourable policy change in the sector over the last 10 years, although the jury is still out on who has been able to muscle the greatest advantage. But this is an opportunity to start afresh, if not in toto, at least in the case of allocating the sensitive 3G spectrum to parties that value it the most.

Illustration: Jayachandran /Mint

When India’s telecom sector opened for private participation in 1995, bids for mobile licences were impossibly high, driven perhaps by the irrational exuberance of the nascent yet promising market. Within a few years of their operation, the mobile operators collectively and successfully petitioned the government to reduce the licence fee burden, which was converted from the fixed bid amount to a more risk-neutral revenue share payment. True, the government largesse created, in the lingua franca of economists, a “moral hazard", but the mid-term policy correction crafted an operating environment which paved the way for service providers to take maximum advantage from the ensuing technological and regulatory changes to usher in the mobile revolution we are witnessing today.

The sector now boasts of revenues in excess of Rs1.3 trillion. Almost 60% of this is attributable to mobile services. Mobile phones outnumber fixed connections by nearly seven-to-one and if the current growth is maintained, the disparity will only widen in the short to medium term. Viewed inter-temporally, therefore, the government’s decision to switch to revenue share licence fee in 1999 was not an incorrect one, even when assessed with respect to the sectors’ financial contribution to the exchequer.

This experience, however, should not be taken as evidence in support of government accommodating business risks. It should be a rare exception, if at all. Yet, it is equally important for the government to resist the political temptation of using the auction to boost finances, thereby potentially raising business risk.

That the government was thinking exactly along these lines became evident when the department of telecommunications (DoT) was asked to increase the reserve price for the pan-India 3G spectrum licence from Rs2,020 crore to Rs2,500 crore. DoT ignored that, saying the auction would discover the best price. Indeed, it should—provided the auction is executed well.

Paul Klemperer, an authority on auction design from Nuffield College, has famously stated that an auction’s design is not “one size fits all". It must be tailored both to its environment, and to the designer’s objectives. In India’s case, the twin objectives should be to ensure the transparency and integrity of the process. To focus chiefly on extracting maximum rents from bidders sends the wrong signals and may result in stunting the growth of 3G services, an outcome of the 3G auction in the UK in 2000.

In any case, given that India is the world’s fastest growing mobile market, revenue realization will happen of its own accord. It is another matter whether it will be to the extent the government hopes i.e., Rs30,000-40,000 crore. But instead of focusing on revenue and tinkering with the reserve price, India’s history calls for attending to two features of good auction design: attracting entry and preventing collusion. If these can be ensured, prima facie it appears that bids will be healthy.

DoTs guidelines allow all 2G licensees—whether or not they have started operations—to bid. Prospective new entrants without 2G licences can also bid, provided they have 3G experience and pay an additional 2G entry fee of Rs1,651 crore for a nationwide licence. This should ensure that the number of bidders exceeds the number of licences to be given (four per circle on average, with the fifth reserved for public sector operators BSNL and MTNL). The incumbent 2G mobile-phone operators will have an advantage over other bidders because of lower costs of building 3G networks (they can piggyback on their 2G infrastructure), but this may also tend to inflate bids because the combined “value" of both licences will exceed that of two independently held licences.

If an ascending auction is chosen (as it seems it will), care should be taken that incumbents do not “collusively" divide the licences. Ascending auctions can deter weaker rivals since a stronger bidder can rebid to top any bid the weaker bidder makes. By contrast, a (first-price) sealed-bid auction provides no opportunity to support collusion. This apart, other factors that would attenuate the “winners curse" are auction timing and the fact that players have had the time to learn from the earlier 3G auctions around the world and will adjust their strategies accordingly. Current capital market constraints might also affect the bids, but the Indian mobile market presently dominated by voice might throw up some surprises when the data-friendly 3G spectrum goes under the hammer.

Rajat Kathuria, a former consultant at Trai, is now a professor at Icrier, New Delhi. Comment at