How Scary is Wireless Duopoly?

by on March 15, 2012 · 19 comments

I’m puzzled by Harold Feld’s latest post. Last month, Harold laid out his argument that society faces a tradeoff between allocating the wireless spectrum to the highest bidder and maintaining competition in wireless services. I responded by showing geometrically that in most cases, efficient production is much more important than maximal competition; in economics, trapezoids are bigger than triangles.

Harold seemed to get it. My argument was only an intuitive one, but he admitted that he needed to be more rigorous to show that competition in the wireless industry is more important than lowering the cost of producing wireless services.

Today, Harold reprised nearly the same post, without additional economic rigor, and at greater length. So maybe you can see why I’m puzzled.

I continue to believe that trapezoids are bigger than triangles. But for this post, let’s put that issue to the side to focus on duopoly, of which Harold seems to have a visceral fear. He’s probably not alone.

Duopoly sounds really bad, because it’s 1 away from monopoly. But modern economists tend not to place too much emphasis on the number of competitors in an industry, at least not in isolation from other factors. For instance, it is well understood that under what is known as a Bertrand duopoly, economic profits to the firms are zero, and the price to consumers is as low as it is when there are many firms. That does not sound too scary, does it?

Duopoly can be consistent with vigorous competition. For instance, most of the bestselling digital SLR cameras on are made by either Nikon or Canon. Sure, a few other companies have a toehold in the industry, but it is as much a duopoly as the wireless industry is. Despite the dominance of these two firms, the price of DSLRs falls every year, and quality continuously goes up.

So what clues can we look at to see if AT&T and Verizon constitute a harmful or a harmless duopoly? The first one is profits. Now, this is tricky, because we want to look at economic profits, which are not the same as accounting profits. Economic profits are usually less than accounting profits, since we need to subtract out the ordinary return to the physical capital owned by the firm. However, even if we look at accounting profits, it turns out that both AT&T and Verizon lost money last quarter. This is not the kind of thing that nasty duopolies tend to do. Now, it could be that both firms had a bad quarter, and they will be back in the black soon. In fact, that is what I expect. But even so, neither firm is likely to rake in profits hand over fist any time soon—and if you think they are, you should put your money where your mouth is and buy their stock.

Another clue we can look at is fixed costs. In an industry with high fixed costs of being in business, lots of companies is neither a stable equilibrium nor a desirable outcome. Suppose there is an industry in which fixed costs are $100 billion. This would mean that for there to be 10 firms, society would have to pay $1 trillion in fixed costs. By reducing the number of firms from 10 to 2, society saves $800 billion. This situation roughly exists in the market for large, commercial jet aircraft, where the only competitors are Boeing and Airbus. Would we really want there to be more commercial jet producers? There would be a whole lot of duplication of costs, and the price of jetliners and air travel would increase, not decrease. We’re better off with a duopoly, and in fact we get duopoly precisely because vigorous competition between the jumbojet giants keeps everyone else out.

Wireless service also has high fixed costs, or, more accurately, declining average costs. Harold notes that if AT&T had been allowed to buy T-Mobile, “it would enjoy ‘synergies.’ Combining with T-Mo would make it bigger, better able to extract the value (by laying off ‘redundant’ T-Mo staff and other cost cutting measures).” I’m not sure why he puts sneering quotation marks around “redundant;” those redundancies represent exactly the socially-beneficial fixed cost-cutting I am talking about. If the industry were not to need those employees any longer, then they could be employed elsewhere, which is what is best for society. If Harold has some other normative criterion, he should come out with it.

The bottom line is that appeals to competition based solely on the number of competitors are just no longer persuasive to anyone up on the economics of firms and industries, also known as industrial organization. As both an avid consumer of wireless service and someone with more than a little fondness for IO, I’m not scared of wireless duopoly at all.

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