Call it what you want: a bailout, a thumb on the scales, bidder restrictions–the FCC might conspicuously intervene in the 2015 incentive auctions at the behest of smaller carriers and public interest advocates.

Chairman Wheeler’s recent comments indicate the FCC may devise a way to prevent the largest two carriers–AT&T and Verizon–from purchasing “too much” of the television broadcasters’ spectrum at auction. AT&T likely sees the writing on the wall and argues that if there are auction limits, the restrictions should apply only to the auction, rather than more extreme restrictions that would penalize AT&T and Verizon, the largest carriers, for previously-acquired spectrum. As The Switch’s Brian Fung put it,

the small carriers favor what are called “asymmetric” spectrum caps that affect various carriers differently, while opponents prefer “symmetric” caps that don’t account for existing market positions.

While I wish AT&T put up more of a fight to auction interventions, they (and staff at the FCC) are handicapped in pursuing an unrestricted auction. The blame lies mostly with Congress who gave the FCC vague (thus ripe for abuse) and conflicting mandates spanning decades. The 1993 law authorizing auctions, for instance, requires the FCC to “avoid[] excessive concentration of licenses” and to “disseminat[e] licenses among a wide variety of applicants” among other regulatory carve-outs for smaller competitors. These latter requirements, if implemented as rigorously as smaller carriers would like, directly undermine the purpose of the 2012 American Taxpayer Relief Act that requires the upcoming spectrum auctions raise $7 billion for a public safety broadband network and $20 billion for deficit reduction.

By asymmetrically penalizing AT&T and Verizon, the FCC increases the probability the auction fails to raise the tens of billions of dollars needed (see Fred Campbell’s recent paper). I haven’t heard a policymaker speak about the incentive auction without remarking how extraordinarily complex it is. That complexity–as was made clear in this week’s Senate hearing on the subject–means no one knows how much spectrum will be auctioned off or how much money will be raised. I was doubtful the FCC would secure the called-for 120 MHz for auction in the first place, but the Senate hearing convinced me that they might not get even 60 MHz. If the FCC meddles too much and the broadcasters aren’t assured they’ll get top dollar for their spectrum, the broadcasters might not show up to sell.

For many reasons, the FCC should ignore the pressures to restrict the large carriers in bidding. Smaller carriers argue the large carriers will outbid them only to preclude competition and hoard the spectrum. Every major carrier is spending billions to expand its footprint and capacity rapidly so the hoarding argument is hard to accept (not to mention, carriers face FCC build out requirements). The hoarding argument also confounds me because AT&T and Verizon are at the forefront arguing for more spectrum auctions, particularly spectrum from federal agencies. Would they want the market flooded with new spectrum only so they could spend billions to hoard it?

Asymmetric auction restrictions also resemble a bailout for smaller carriers. T-Mobile and Sprint–who most actively lobby for auction restrictions–are not mom-and-pop establishments. Each is a sophisticated, powerful corporation with access to capital markets and backed by larger international telecoms–Germany’s Deutsche Telekom for T-Mobile and Japan’s SoftBank for Sprint. DT and SoftBank have both pledged to spend billions in the next few years to improve their American carrier’s competitive position. Such carriers do not need an FCC handout.

The bailout resemblance is more apparent when you realize Sprint has been hamstrung for nearly a decade with damaging business decisions. Three come immediately to mind: 1) the dreadful merger with Nextel in 2005; 2) the ill-fated bet in 2008 to forgo LTE rollout in favor of WiMax, a competing 4G standard; and 3) the loss of over one million customers when it discontinued its push-to-talk iDEN service for network upgrades. The losses from the Nextel merger alone approach $30 billion.

To be clear, I don’t second-guess Sprint’s decisions. They did what innovative firms are supposed to do in attempting big, risky investments. However, it should not be the job of the FCC to favor some firms through spectrum auctions because some carriers’ business decisions did not pan out. That is not a competitive wireless auction–that is an FCC-orchestrated bailout. Granted, the FCC has been handed conflicting mandates. The Commission has ample discretion, however, to conduct a competitive auction that both complies with the law and improves chances of reaching the ambitious revenue goals. Intense meddling with auction results could prove disastrous.

It could be argued that the exact match between the DISH bid commitment and the H block reserve price is purely coincidental. To actually believe this was a coincidence would require the same willing suspension of disbelief indulged by summer moviegoers who enjoy the physics-defying stunts enabled by computer-generated special effects. When moviegoers leave the theater after watching the latest Superman flick, they don’t actually believe they can fly home.

The FCC’s Wireless Bureau recently adopted an unusually high $1.564 billion reserve price for the auction of the H block spectrum. Though the FCC has authorized the Bureau to adopt reserve prices based on its consideration of “relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned,” it appears the Bureau exceeded its delegated authority in this proceeding by considering factors unrelated to the value of the H block spectrum that have the effect of giving a particular firm an advantage in the auction. Specifically, the Bureau considered the value to DISH Network Corporation of amendments to FCC rules governing other spectrum bands already licensed to DISH (e.g., the 700 MHz E block) in exchange for DISH’s commitment to meet the $1.564 billion reserve price in the H block auction – a commitment that is contingent on the FCC Commissioners amending rules governing multiple spectrum bands no later than Friday, December 13, 2013.

No matter what the FCC Commissioners decide, if the reserve price stands, the only sure winner would be DISH. If the FCC Commissioners  don’t endorse the DISH deal, DISH need not honor its commitment to meet the artificially inflated reserve price, which could result in the spectrum auction’s total failure. If the Commissioners do endorse the DISH deal, the artificially inflated reserve price could deter the participation of other bidders and lower auction revenues that are expected to fund the national public safety network. Neither option would result in an open and transparent auction designed to provide all potential bidders with a fair opportunity to participate.

The FCC would be the only sure loser. The appearance of impropriety in the H block proceeding could compromise public trust in the integrity of FCC spectrum auctions. To ensure the public trust is maintained, the FCC Commissioners should thoroughly review the processes and procedures implemented by the Wireless Bureau in this proceeding before auctioning the H block spectrum.

The following discussion provides background information on the purposes of spectrum auctions and reserve prices. This background information is followed by a more detailed analysis of the terms of the DISH deal and the advantages it would bestow on DISH, the lack of analysis in the Wireless Bureau’s order, the role of the Commissioners, and the potential damage to the integrity of FCC auctions.

The Purpose of Spectrum Auctions

FCC spectrum auctions are intended to assign licenses to the firms that value the spectrum most highly, who are presumed to be most likely to provide the highest quality and most timely service to the public. Though this presumption was controversial when Congress first authorized spectrum auctions in 1993, twenty years and eighty-two auctions later, there is widespread agreement that open and transparent auctions have generally succeeded in licensing spectrum to the most efficient firms while minimizing delays in service to the public, preventing unjust enrichment, and providing revenue to the public treasury. Like any other market-based mechanism, however, competitive bidding mechanisms are vulnerable to market distortions. When the rules governing a spectrum auction are likely to produce market distortions, it weakens the presumption that the resulting auction is likely to award spectrum licenses to the most efficient firms.

The Purpose of Reserve Prices

The FCC has previously concluded that artificially inflated reserve prices are likely to result in market distortions.

The Balanced Budget Act of 1997 established a presumption requiring the FCC to impose minimum opening bids or reserve prices in FCC auctions unless it is not in the public interest. ( See FCC 97-413 at ¶ 139) Traditionally, reserve prices are used to maximize auction revenue and cannot be lowered once an auction begins. In its order implementing the Balanced Budget Act, the FCC determined that the minimum opening bid/reserve price requirement was not intended to require traditional reserve prices designed to maximize auction revenue – the provision was intended only as protection against assigning spectrum licenses at unacceptably low prices. (See id. at ¶ 140) The FCC thus directed the Wireless Bureau to consider only “relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned” when establishing reserve prices. (See id. at ¶ 141 (emphasis added))

It is implicit in this delegation of authority that the Wireless Bureau cannot consider factors that are  irrelevant to the valuation of the spectrum being auction. As the Bureau has previously recognized, establishing reserve prices based on factors that are unrelated to the valuation of the spectrum being auctioned could artificially inflate reserve prices, which could deter bidders from participating in the auction and preclude the assignment of the spectrum to the most efficient firms. (See DA 97-2147 at ¶¶ 13-14)

Despite its lack of delegated authority to do so, it appears that the Wireless Bureau considered irrelevant factors that may have artificially inflated the reserve price in the H block auction, including the value to DISH Network Corporation of amendments to FCC rules governing other spectrum bands already licensed to DISH. There is no rational (let alone reasonable) relationship between amendments to rules governing other spectrum bands that are  uniquely valuable to a particular firm and the value of the H block spectrum generally. The Bureau nevertheless considered the unique interests of DISH while playing a larger game of Let’s Make a Deal involving otherwise unrelated FCC proceedings.

The Deal with Dish

The terms of the deal with DISH were memorialized in an  ex parte letter (DISH Letter) filed by DISH in WT Docket No. 12-69 (“Promoting Interoperability in the 700 MHz Commercial Spectrum”) on September 10 (three days before the Wireless Bureau issued its order establishing the H block reserve price), and a petition for waiver (DISH Petition) filed by DISH on September 9 (which has not yet been assigned a docket number). According to these deal documents, DISH agreed to:

• Consent to a reduction in the power limits currently applicable to its E block spectrum in the lower 700 MHz band (see DISH Letter at 2-3); and

• Bid “at least a net clearing price equal to any aggregate nationwide reserve price established by the Commission in the upcoming H Block auction (not to exceed the equivalent of $0.50 per MHz/POP [i.e., $1.564 billion])” in order “to provide critical funds for FirstNet.” (DISH Petition at 2)

DISH stated that its consent and bid commitment are “contingent” on FCC actions to:

• Extend DISH’s buildout deadlines in both the lower 700 MHz E block and the AWS-4 band; and

• Authorize DISH to operate its AWS-4 spectrum in the 2000-2020 MHz band, which currently must be used only as uplink, as either uplink or downlink. (See DISH Letter at 2-3)

In the DISH Letter, DISH stated its “anticipat[ion] that the Commission will adopt a final order effectuating these changes no later than December 31, 2013,” including the “ grant in its entirety” of the DISH Petition. (See Dish Letter at 2-3 (emphasis added)) In the DISH Petition, DISH stated that the FCC must adopt an order effectuating these changes “at least 30 days prior to the commencement of the H Block auction,” or its $1.564 billion bid commitment “shall no longer apply.” (See DISH Petition at 15) After the DISH Petition was filed, the Wireless Bureau ordered the H block auction to commence on January 14, 2014, which means DISH’s bid commitment applies only if the FCC Commissioners grant the DISH Petition in its entirety and modify the rules governing the 700 MHz E block no later than Friday, December 13, 2013.

Despite the fact that the deal gives the FCC Commissioners less than three months to grant DISH’s desires, DISH would have  two and one-half years from the date the DISH Petition is granted to file an election stating whether it would deploy the 2000-2020 MHz band for downlink or uplink. (See DISH Petition at 1-2)

The Advantages Bestowed on Dish

If DISH were given the ability to elect whether to deploy the 2000-2020 MHz band for downlink or uplink for nearly two and one-half years  after the H block auction concludes, DISH would have a substantial advantage in the auction relative to other potential bidders.

A discussion of the relationship between the H block and the AWS-4 spectrum and previous industry positions regarding this relationship is informative when analyzing the advantages bestowed on DISH and how it could affect the strategies of other potential bidders.

The current uplink requirement in the AWS-4 spectrum at 2000-2020 MHz and the downlink requirement in the adjacent H block spectrum at 1995-2000 MHz creates “particularly difficult technical issues” that “affect the use and value” of these bands. ( See FCC 12-151 at ¶¶ 53, 65 (AWS-4 Order)) The deployment of downlink and uplink in adjacent bands increases the potential for harmful interference from out-of-band emissions (OOBE) and receiver blocking (or “overload”). (See AWS-4 Order at ¶ 72) In the AWS-4 proceeding, DISH argued that these interference issues meant the H block could not be auctioned at all and must be treated as a guard band (which would have eliminated most of its value). (See id. at ¶¶ 66, 69) The FCC chose to reduce the utility (and thus the value) of the AWS-4 spectrum instead by (1) increasing the OOBE limits applicable to the 2000-2020 MHz band, (2) limiting the power of mobile terrestrial devices in the 2000-2005 MHz portion of the AWS-4 band, and (3) requiring that DISH accept any OOBE and overload interference into that portion of the AWS-4 band caused by future, lawful operations in the H block. (See id. at ¶ 72) According to DISH, these restrictions render the 2000-2005 MHz portion of its AWS-4 spectrum unsuitable for mobile services.

In its order establishing service rules for the H block (H Block Order), the FCC noted that DISH had accepted the limitations on its AWS-4 spectrum and that “nothing [in the H Block Order was] intended to revisit these determinations.” (H Block Order, FCC 13-88 at ¶ 49) The FCC did, however, “specifically adopt . . . rules to adequately protect operations in adjacent bands, including the . . . 2000-2020 MHz AWS-4 uplink band.” (Id. at ¶ 48) These rules include a “more stringent OOBE limit of 70 + 10 log10 (P) dB, where (P) is the transmitter power in watts, for transmissions from the Upper H Block into the 2005-2020 MHz AWS-4 band.” (See id. at ¶ 59-60 (the FCC typically applies an OOBE limit of 43 + 10 log10 (P) dB at the edges of mobile bands only)) Sprint (who holds all of the licenses for the PCS G Block, which is contiguous with and complementary to the H block) had advocated for a less stringent limit of 60 + 10 log10 (P) dB across the 2005-2020 MHz band, and DISH (who holds all of the AWS-4 licenses) had advocated for an even more stringent 79 + 10 log10 (P) dB limit. (Id. at ¶ 65) The FCC split the difference, finding that an OOBE limit of 70 + 10 log10 (P) dB was “more consistent with the balancing of interference concerns between the AWS-4 and H Block bands discussed in the [AWS-4 Order]” than the less stringent limits proposed by Sprint and the more stringent limits proposed by DISH. (See id. at ¶ 68-73) The FCC also noted that licensees in the H block and the AWS-4 band could agree to modify the technical restrictions governing interference between these bands through private negotiation. (See AWS-4 Order at ¶ 73; H Block Order at ¶¶ 65, 208)

Relationship Between H Block & AWS-4 Spectrum

If the FCC Commissioners were to endorse the DISH deal, it would give DISH the  unilateral ability to rebalance the interferences issues the FCC previously considered and resolved in its 2012 AWS-4 Order and its 2013 H Block Order – a unilateral ability that DISH could choose to exercise after the H block auction concludes. This would create a significant information asymmetry between DISH and all other potential bidders in the H block auction, which would improve DISH’s bidding position relative to other firms and potentially deter their participation in the auction. For example, if DISH were to elect to use the AWS-4 spectrum for downlink, it would mitigate the interference concerns that currently exist between the H block and ASW-4 bands, which would tend to increase the value of the H block to all potential bidders. Because DISH would have the unilateral ability to stall its election for nearly two and one-half years after the H block auction ends, however, DISH would be uniquely positioned to accurately assess the probability that it would choose to mitigate interference concerns by electing the downlink option. In these circumstances, other firms are likely to discount or ignore entirely whatever increase in value they would otherwise accord to the H block spectrum based on the mere possibility that DISH could elect to limit the 2000-2020 MHz band to downlink transmissions.

The proposed downlink election would also give DISH leverage in subsequent interference negotiations between itself and future H block licensees, which would tend to lower the bids of other firms while simultaneously limiting DISH’s incentive to bid any higher on the H block spectrum than its commitment would otherwise require. Assume, for example, that DISH meets its commitment by bidding the $1.564 billion reserve price but is subsequently outbid by Sprint. In the absence of the proposed election right, DISH would have an incentive to raise its previous bid because, if DISH owned both the H block and the AWS-4 spectrum, it could unilaterally eliminate the technical restrictions on both bands through private agreement with itself (a common practice when a single licensee owns spectrum across multiple blocks or bands). With the downlink election right, however, DISH’s incentive to bid on the H block in order to mitigate interference would be substantially diminished, because DISH could use its election right as leverage in post-auction interference mitigation negotiations with Sprint.

For example, assuming Sprint wins the H block, it would have an incentive to seek DISH’s agreement to the less stringent OOBE limits Sprint sought, but did not obtain, in the H block rulemaking proceeding. DISH likewise would have an incentive to seek Sprint’s agreement to technical parameters that would allow DISH to use the 2000-2005 MHz portion of the AWS-4 band for mobile services, which is something DISH sought, but did not obtain, in the AWS-4 and H block rulemaking proceedings. Because the downlink election would mitigate the interference concerns the FCC was required to balance in these rulemaking proceedings, it is possible DISH could use the election right to rebalance the technical rules in its favor (and thus increase the value of its AWS-4 spectrum)  without paying for the H block spectrum at auction or paying to obtain the agreement of the H block licensees (in this hypothetical, Sprint). This possibility would tend to lower the price DISH would be willing to pay for the H block spectrum at auction while giving Sprint and other potential bidders incentives to discount their bids to account for the potential costs of their subsequent interference negotiations with DISH.

In effect, endorsing the DISH deal would provide DISH with an implicit government subsidy for its anticipated interference negotiations, the cost of which would be borne by the government (and, ultimately, public safety) in the form of lower auction revenues for the H block, which would tend to explain the Bureau’s decision to adopt the unusually high H block reserve price proposed by DISH.

The Lack of Analysis

Despite the obvious connection, the Wireless Bureau did not cite the DISH Letter or DISH Petition in its order adopting DISH’s minimum bid commitment as the reserve price for the H block auction. The Bureau didn’t discuss the DISH deal at all. It instead cited a brief ex parte letter (DISH Ex Parte) filed by DISH in the H block auction proceeding (AU Docket No. 13-178) on the same day DISH separately filed the DISH Petition (which has not yet been assigned a docket number).

The DISH Ex Parte also neglects to mention the DISH Petition filed that same day or the deal memorialized in the DISH Letter filed in WT Docket No. 12-69 the following day. The DISH Ex Parte addresses the reserve price issue in a single paragraph, which states only that “DISH estimates that the value of the H Block is at least $0.50 per” MHz-Pop on a nationwide aggregate basis (i.e., $1.564 billion) based on recent auctions and secondary market sales. ( See DISH Ex Parte at 1 (citing the 2006 AWS-1 auction, the Verizon SpectrumCo transaction, and a Morgan Analyst Report)). Though it states the value of the H block is “at least” $1.564 billion, the DISH Ex Parte does not offer any analysis indicating that this estimate is an appropriate reserve price based on factors considered relevant by the FCC when establishing reserve prices – and neither does the Wireless Bureau’s order.

As noted above, the FCC has determined that reserve prices should be used only as protection against assigning licenses at unacceptably low prices and not as a tool to maximize auction revenue. In its order delegating authority to the Wireless Bureau to establish minimum opening bids or reserve prices, the FCC directed the Bureau to consider “the amount of spectrum being auctioned, levels of incumbency, the availability of technology to provide service, the size of the geographic service areas, issues of interference with other spectrum bands, and any other relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned.” ( See FCC 97-413 at ¶ 141) The Wireless Bureau didn’t discuss any of these factors in its order adopting the H block reserve price or find that a lesser amount would be “unacceptably low” (which seems unlikely given the more stringent technical limitations imposed on the H block in order to mitigate its “particularly difficult technical issues”). The Bureau simply concluded without analysis that the amount of DISH’s bid commitment is “appropriate” given the Spectrum Act’s requirement to use the auction proceeds for public safety purposes. (See DA 13-1885 at ¶ 172) The reasons why the Bureau believes this particular amount is appropriate were left unstated.

Though the FCC has occasionally adopted relatively high reserve prices in the past, they were expressly based on the potential value of the spectrum being auctioned or statutory incumbency issues. For example, in Auction 66, the FCC adopted a relatively high reserve price to ensure the auction raised enough revenue to relocate incumbent federal spectrum users as required by statute. The FCC also adopted relatively high reserve prices in Auction 73 because it was concerned that the unique public interest obligations and stringent buildout requirements it had imposed on that spectrum could result in unacceptably low auction prices. Safeguarding against the assignment of spectrum at unacceptably low prices due to factors relevant to the valuation of the spectrum being auctioned is the purpose the reserve price requirement is intended to serve.

As noted above, however, the FCC has concluded that it is inappropriate to adopt a high reserve price merely to maximize revenue (no matter how noble the cause) or to serve purposes unrelated to the spectrum being auctioned, because reserve prices adopted for such reasons are more likely to result in a failed auction. The irony in this instance is that, if the unusually high reserve price makes it more likely that the H block auction could fail, public safety could be worse off than if there were no reserve price at all. It is also ironic that DISH’s bid commitment is  itself evidence that the reserve price adopted by the Bureau is artificially inflated. If the H block spectrum were actually worth “at least” as much as DISH estimates (and DISH were actually interested in winning it), DISH would not have had a legitimate reason to make its H block bidding commitment contingent on the FCC granting “in its entirety” the relief sought by DISH.

The unusually high reserve price placed on the H block spectrum is especially troubling given the obvious implication that the Bureau’s decision was driven primarily by factors unrelated to  either the value of the H block or the interests of public safety – i.e., it appears the Bureau was motivated by the DISH deal’s role in resolving interoperability issues in the 700 MHz band. Though that is undoubtedly a noble goal, it is ignoble to achieve it by compromising the integrity of an unrelated spectrum auction.

It could be argued that the exact match between the DISH bid commitment and the H block reserve price is purely coincidental. The Bureau’s failure to mention that DISH had concurrently filed a petition committing to bid an amount identical to its suggested reserve price is not, however, enough to satisfy a claim of coincidence that meets the straight face test. To believe this was a coincidence would require the same willing suspension of disbelief indulged by summer moviegoers who enjoy the physics-defying stunts enabled by computer-generated special effects. When moviegoers leave the theater after watching the latest Superman flick, they don’t actually believe they can fly home.

The Role of the Commissioners

The particular process followed by the Wireless Bureau in this instance creates additional risk that the auction could fail and leave public safety with no revenue from the H block.

The Bureau’s adoption of an unusually high reserve price was presumably premised on the notion that, even if the reserve price is artificially inflated, there is little risk that the H block auction would fail because DISH committed to meet the reserve price. The problem with this premise is that DISH’s commitment is contingent on the FCC Commissioners agreeing to grant DISH specific relief before the auction, a decision that is outside the Bureau’s control. If the full FCC chooses to deny the DISH Petition and other rules changes sought by DISH, or simply fails to act within the requisite time, the H block auction may have to proceed  with an artificially inflated reserve price and without any commitment by DISH to meet it.

In these circumstances, the Bureau’s decision to adopt an unusually high reserve price also has the effect of placing inappropriate pressure on the FCC Commissioners to act in accordance with the will of the Bureau. If the H block auction procedures stand, the options of the Commissioners would appear to be limited to (1) endorsing the DISH deal or (2) risking the failure of the H block auction due to the unusually high reserve price, which could in turn delay the payment of auction revenue slated for use by public safety. The Wireless Bureau’s decision thus has the effect of forcing the Commissioners into making a Hobson’s choice.

Given that the H block reserve price is based on considerations that lie outside the scope of the Bureau’s delegated authority, the reserve price should only have been approved (if at all) by a full FCC vote after a thorough analysis of its potential impact. In no event should the Bureau have adopted DISH’s proposed reserve price without a reasonable opportunity for comment by the public and thorough consideration by the Commissioners, especially given its potential impact on other spectrum bands.

The Integrity of FCC Auctions

The process for adopting the reserve price in the H block proceeding begs the question: Was this intended to be an open and transparent auction designed to assign H block licenses to the firms that value them most highly  or a privately negotiated retail sale designed to ensure a minimum level of auction revenue while accomplishing unrelated policy goals that also benefit a particular firm? No matter the answer, the fact that this question must be asked is enough to compromise the public’s trust in the ability and willingness of the FCC to conduct open and transparent spectrum auctions that provide all potential bidders with a fair opportunity to participate. To restore public trust in the integrity of FCC auctions, the Commissioners should thoroughly review the Wireless Bureau’s competitive bidding processes and procedures before auctioning the H block spectrum.

The Mercatus Center at George Mason University has just released a new paper by Brent Skorup and me entitled, “A History of Cronyism and Capture in the Information Technology Sector.” In this 73-page working paper, which we hope to place in a law review or political science journal shortly, we document the evolution of government-granted privileges, or “cronyism,” in the information and communications technology marketplace and in the media-producing sectors. Specifically, we offer detailed histories of rent-seeking and regulatory capture in: the early history of the telephony and spectrum licensing in the United States; local cable TV franchising; the universal service system; the digital TV transition in the 1990s; and modern video marketplace regulation (i.e., must-carry and retransmission consent rules, among others.

Our paper also shows how cronyism is slowly creeping into new high-technology sectors.We document how Internet companies and other high-tech giants are among the fastest-growing lobbying shops in Washington these days. According to the Center for Responsive Politics, lobbying spending by information technology sectors has almost doubled since the turn of the century, from roughly $200 million in 2000 to $390 million in 2012.  The computing and Internet sector has been responsible for most of that growth in recent years. Worse yet, we document how many of these high-tech firms are increasingly seeking and receiving government favors, mostly in the form of targeted tax breaks or incentives.

We argue that the creeping cronyism could have two major negative ramifications. First, it could dull entrepreneurialism and competition in this highly innovative sector since time and resources spent on influencing politicians and capturing regulators cannot be spent competing and innovating in the marketplace. Cronyism will also negatively impact consumer welfare by denying consumers more and better products and services. Additionally, consumers might end up paying higher prices or higher taxes due to government privileges for industry.

Second, cronyism also raises the specter of greater government control of the Internet and of the digital economy. When policymakers dispense favors, they usually expect something in return. They also become accustomed to having greater informal powers over the sector receiving favors, and contribute to DC’s infamous “revolving door” problem.

High-tech America’s recent embrace of Washington could take it down the familiar path followed by the agriculture, telecommunications, and automotive sectors (among many others), with government becoming both protector and punisher of industry. Today’s dynamic tech industries will increasingly come under the “Mother, may I?” permission-based regulatory regime that encumbered the older information technology sectors.

Finally, this paper offers strategies for stalling and diminishing the cronyism already taking root in the high-tech sector. We suggest several targeted reforms to limit or undo cronyism. Generally speaking, however, we note that, as economist David R. Henderson argued in an earlier Mercatus Center report, “There is only one way to end, or at least to reduce, the amount of cronyism, and that is to reduce government power.”

The paper can be downloaded from the Mercatus website, SSRN, or Scribd. The Scribd version is embedded down below. (Also, here’s some coverage of the paper over at the Washington Post’s “Wonkblog” from our old colleague Tim Lee. Here’s more coverage from Bloomberg Businessweek and the San Francisco Chronicle. And here’s a U.S. News oped that Brent and I wrote condensing our paper into just 600 words. Finally, a short 3-minute video of me discussing the problem of tech cronyism is also embedded below.)

A History of Cronyism and Capture in the Information Technology Sector [Thierer and Skorup – July 2013] by Adam Thierer

“Permitting voluntary spectrum transactions between federal and commercial users would harness the power of market forces to put both commercial and federal spectrum to its highest and best uses.”

The House Energy and Commerce Committee’s Subcommittee on Communications and Technology is holding a hearing today to ask, “How can Congress meet the needs of Federal agencies while addressing carriers’ spiraling demand for spectrum in the age of the data-intensive smartphone?” In my view, the answer requires a flexible approach that permits experimentation among multiple approaches.

There are challenges and opportunities for  both (1) clearing and reallocating federal spectrum for commercial use and (2) sharing spectrum among federal and commercial users. Economic and technical issues may require different strategies for different spectrum bands and different uses. Experience indicates that voluntary negotiations among interested parties – not bureaucratic fiat – are likely to produce the most efficient strategy in any particular instance. Unfortunately, current law does not provide market incentives or mechanisms for the relevant parties (federal and commercial spectrum users and spectrum regulators) to achieve efficient outcomes.

Congressional action creating markets for spectrum transactions between federal and commercial users would provide the relevant parties with an opportunity to maximize their spectrum use through voluntary negotiation. A market-oriented approach would permit experimentation, encourage innovation, and promote investment while increasing the efficiency of spectrum use. The result would benefit consumers, federal agencies, and the economy.

Federal users lack incentives to relinquish or share spectrum with commercial users

The law requires the NTIA and FCC to jointly plan spectrum allocations to accommodate all users and promote the efficient use of the spectrum. Although the agencies have agreed to share spectrum when the potential for harmful interference is low, the NTIA typically does not voluntarily agree to repurpose federal spectrum for exclusive commercial use. That typically requires a Presidential memorandum, Congressional legislation, or both.

The reason: NTIA and its constituent federal spectrum users have no  incentive to voluntarily relinquish federal spectrum rights.

First, government agencies generally cannot profit from relinquishing their spectrum (i.e., they are not subject to the opportunity costs applicable in commercial markets). They are entitled to reimbursement for the costs of relocating their wireless systems after a commercial spectrum auction, but the majority of auction proceeds are remitted to the general Treasury.

Second, government agencies face an uncertain funding environment (i.e., they cannot raise capital in commercial markets). Agencies often reserve federal spectrum allocations for planned wireless systems that are unfunded, which can result in federal spectrum lying fallow for years. An agency that reserves spectrum for a planned system can remain optimistic that it will receive funding in the next budget cycle. But, if the agency relinquishes its spectrum, it cannot build the planned system even if it does receive funding.

The lack of potential benefits and the funding uncertainty inherent in the government budgeting process combine to create an environment in which federal agencies have low opportunity costs for reserving spectrum and high opportunity costs for relinquishing it. Creating market mechanisms that  reverse these opportunity costs would provide government agencies with incentives to voluntarily relinquish or share their spectrum in ways that promote overall spectrum efficiency.

Federal users lack incentives to share spectrum with other federal users

The lack of incentives for efficient use of federal spectrum extends to intra-agency sharing as well.

There are approximately eighty different federal entities that are authorized to use federal spectrum. It would be more efficient for multiple agencies to share spectrum and systems in certain bands, but the lack of market incentives combined with jurisdictional issues make it difficult for them to work together. For example, DOJ, DHS, and DOT tried to build a shared wireless network for voice communications, but, “despite costing over $356 million over 10 years,” the project failed to achieve the results intended.

Market mechanisms that permit federal agencies to profit from their spectrum could eliminate the funding issues and alleviate the “turf wars” that plague intra-agency projects.

Potential mechanisms for repurposing federal spectrum

The current proposals for repurposing federal spectrum fall into three general categories.

One option is to create a GSA-like agency for federal spectrum users. This would provide an incentive for efficient use of federal spectrum by imposing an opportunity cost for inefficiency (in the form of rents paid by federal spectrum users to the new agency), but it would not improve funding mechanisms for federal wireless systems.

Another option is the sharing-only approach proposed by the President’s Council of Advisors on Science and Technology (PCAST). This approach could provide commercial users with additional access to federal spectrum, but it would not alter federal incentives or funding and lacks the degree of certainty that is typically necessary for substantial commercial investment.

The third option would permit federal spectrum users to sell or lease their spectrum rights and use the funds to build new systems or secure usage rights on commercial systems. This could be accomplished through the use of incentive auctions in some circumstances, though individually negotiated transactions between federal and commercial users would provide significantly more flexibility. This alternative would tend to reverse (by merging) the incentives discussed above: Federal users would face higher opportunity costs for reserving spectrum and lower opportunity costs for relinquishing it.

The third option also has the advantage of permitting multiple approaches to the issue of apportioning spectrum for federal and commercial uses. I expect that, even if government agencies were permitted to engage in secondary market transactions with commercial spectrum users, they would still prefer sharing on a non-interference basis in bands with unique requirements, which would accommodate additional spectrum for unlicensed uses. If it appeared that federal users still lacked sufficient incentives to improve the efficiency of their spectrum use, Congress would retain the option of creating a GSA-like agency to charge rents to federal spectrum users.

Permitting voluntary spectrum transactions between federal and commercial users would harness the power of market forces to put both commercial and federal spectrum to its highest and best uses. As FCC Commissioner Rosenworcel noted recently, “our federal spectrum policy needs to be built on carrots, not sticks.” Giving federal spectrum users an opportunity to negotiate a share in the benefits of repurposing federal spectrum would be a carrot worth pursuing.

The Department of Justice has suddenly reversed course from its previous findings that mobile providers who lack spectrum below 1 GHz can become “strong competitors” in rural markets and are “well-positioned” to drive competition locally and nationally. Those supporting government intervention as a means of avoiding competition in the upcoming incentive auction attempt to avoid these findings by highlighting misleading FCC statistics, including the assertion that Verizon owns “approximately 45 percent of the licensed MHz-POPs of the combined [800 MHz] Cellular and 700 MHz band spectrum, while AT&T holds approximately 39 percent.”

Sprint Nextel Corporation (Sprint Nextel) recently sent a letter to the Federal Communications Commission (FCC) signed by Dick Thornburgh, a former US Attorney General who is currently of counsel at K&L Gates, expressing his support for the ex parte submission of the Department of Justice (DOJ) that was recently filed in the FCC’s spectrum aggregation proceeding. The DOJ ex parte recommends that the FCC “ensure” Sprint Nextel and T-Mobile obtain a nationwide block of mobile spectrum in the upcoming broadcast incentive auction. In his letter of support on behalf of Sprint Nextel, Mr. Thornburgh states he believes the DOJ ex parte “is fully consistent with its longstanding approach to competition policy under Republican and Democratic administrations alike.”

Mr. Thornburgh is mistaken. The principle finding on which the DOJ’s new recommendation is based – that the FCC should adopt an inflexible, nationwide restriction on spectrum holdings below 1 GHz – is clearly  inconsistent with the DOJ’s previous approach to competition policy in the mobile marketplace. Both the FCC and the DOJ have traditionally found that there is no factual basis for making competitive distinctions among mobile spectrum bands in urban markets, and the DOJ has distinguished among mobile spectrum bands only in rural markets.

In its 2006 complaint against the merger of Alltel and Western Wireless, the DOJ found that, in rural markets with relatively low population densities, it cost more to achieve broad mobile coverage using 1.9 GHz PCS spectrum, which made it less likely that providers with PCS spectrum would deploy in those markets. Based on that finding, the DOJ concluded that additional mobile entry would be difficult in certain rural markets in which the combined firm would own all available 800 MHz Cellular spectrum – the only mobile spectrum below 1 GHz that was available on a nationwide basis at that time.

In that same merger proceeding (I was the FCC Chairman’s wireless advisor at the time), the FCC refused to adopt the DOJ’s rural market distinction and instead maintained its traditional view that spectrum bands above 1 GHz are suitable for the provision of competitive services in both urban and rural markets.

Although the DOJ continued to apply its rural market distinction in subsequent merger reviews ( i.e., Alltel/Midwest Wireless and AT&T/Dobson), it recognized that the distinction wasn’t reliably predictive in every rural market and was competitively irrelevant to nationwide competition. For example, in the 2008 Verizon/Alltel merger, the DOJ found that Verizon was a “strong competitor” in rural markets in which Verizon didn’t own any Cellular spectrum below 1 GHz, “because, unlike many other providers with PCS spectrum in rural areas, it has constructed a PCS network that covers a significant portion of the population.” Similarly, in its 2011 complaint against the proposed merger of AT&T and T-Mobile, the DOJ concluded that “T-Mobile in particular” was “especially well-positioned to drive competition, at both a national and local level,” in the mobile market even though T-Mobile owned very little spectrum below 1 GHz at that time.

The DOJ’s new recommendation is a sudden reverse in course from its previous findings that mobile providers who lack spectrum below 1 GHz can become “strong competitors” in rural markets and are “well-positioned” to drive competition locally and nationally.

The DOJ’s sudden reversal is particularly surprising given that the amount of spectrum below 1 GHz has increased substantially since the DOJ adopted its rural distinction in 2006. At that time, the 800 MHz Cellular band was the  only spectrum band below 1 GHz that was broadband-capable and fully available on a nationwide basis. Since then, two additional sub-1 GHz spectrum bands capable of supporting mobile broadband services have become available on a nationwide basis – the 800 MHz SMR and 700 MHz bands. Sprint Nextel owns nearly all of the 800 MHz SMR band nationwide, T-Mobile acquired 700 MHz spectrum through its acquisition of MetroPCS this year, and many rural and regional mobile providers own 800 MHz Cellular and 700 MHz spectrum in rural areas across the country.

Those supporting government intervention as a means of avoiding competition in the upcoming incentive auction attempt to avoid these facts by highlighting misleading FCC statistics, including the assertion that Verizon owns “approximately 45 percent of the licensed MHz-POPs of the combined [800 MHz] Cellular and 700 MHz band spectrum, while AT&T holds approximately 39 percent.” This statistic is misleading in two respects.

First, this statistic  excludes the 800 MHz SMR band, which is owned almost exclusively by Sprint Nextel. Excluding an entire spectrum band below one gigahertz from the statistical calculation creates the misleading impression that Verizon and AT&T hold a higher percentage of mobile spectrum below 1 GHz than they actually do.

Second, the FCC’s “MHz-POPs” methodology is weighted by population, which skews the resulting percentage of spectrum ownership significantly higher for companies that own spectrum in densely populated urban areas. A hypothetical using this methodology to calculate the percentage of “MHz-POPs” in the Cellular Market Areas (CMAs) covering the State of New York demonstrates just how skewed this methodology can be in the spectrum aggregation context.

Assume that “Company A” and “Company B” both own spectrum “Block X” (i.e., both companies own the same amount of spectrum in absolute terms) in different geographic areas in New York State. Specifically, assume that “Company A” owns “Block X” in geographic license area CMA001 (covering New York City and Newark, New Jersey), and “Company B” owns the same spectrum block in the other sixteen CMAs, including all six rural license areas in the state. If their spectrum holdings are calculated using the FCC’s population-weighted “MHz-POPs” methodology, “Company A” holds 70 percent of the “Block X” spectrum and “Company B” holds only 30 percent. (For an explanation of this methodology, see the “Technical Appendix” at the bottom of this post.)

As this example demonstrates, analyzing the percentage of spectrum mobile providers hold on a nationwide basis using the FCC’s “MHz-POPs” methodology is particularly misleading given the DOJ’s determination that spectrum below 1 GHz is competitively relevant only in sparsely populated rural areas. For example, if the FCC were to adopt a rule prohibiting any one mobile provider from holding 50% or more of the spectrum below 1 GHz in New York State on a “MHz-POPs” basis, “Company A” would be in violation of the rule even though it holds spectrum in  only 1 market and doesn’t hold any spectrum in rural markets.

When the 800 MHz SMR band is included and spectrum holdings are evaluated on a market-by-market basis, at least four different mobile providers hold spectrum below 1 GHz in most markets – a result that wasn’t even possible in 2006 (absent nationwide spectrum disaggregation on the secondary market) when the DOJ adopted its rural distinction.

Mr. Thornburgh’s broad statements about the DOJ’s past approach to competition policy generally and the FCC’s skewed statistics are not legitimate, data-based substitutes for a detailed analysis of DOJ precedent and current spectrum holdings below 1 GHz in both urban and rural markets. A detailed analysis indicates that the DOJ’s new recommendation is  not “fully consistent” with its previous approach to competition in the mobile marketplace, though it is consistent with a desire to rig the spectrum auction to favor certain competitors.

Technical Appendix

The FCC calculates “MHz-POPs” by multiplying the megahertz of spectrum held by a mobile provider in a given area by the population of that area.

The FCC also weights spectrum holdings by population using a “population-weighted average megahertz” calculation. The FCC calculates the nationwide “population-weighted average megahertz” of a mobile provider by dividing that provider’s “MHz-POPs” (as calculated above) by the US population.

The calculations for the New York State example in this blog post use “Cellular Market Areas,” which consist of Metropolitan Statistical Area (MSA) and Rural Service Area (RSA) licenses as defined by the FCC in Public Notice Report No. CL-92-40, “Common Carrier Public Mobile Services Information, Cellular MSA/RSA Markets and Counties,” DA 92-109, 7 FCC Rcd. 742 (1992). The population figures are from the 2000 U.S. Census, U.S. Department of Commerce, Bureau of the Census.

” . . . the cooperative process envisioned by the National Broadband Plan is at risk of shifting to the traditionally contentious band plan process that has delayed spectrum auctions in the past.”

The National Broadband Plan proposed a new way to reassign reallocated spectrum. The Plan noted that, “Contentious spectrum proceedings can be time-consuming, sometimes taking many years to resolve, and incurring significant opportunity costs.” It proposed “shifting [this] contentious process to a cooperative one” to “accelerate productive use of encumbered spectrum” by “motivating existing licensees to voluntarily clear spectrum through incentive auctions.” Congress implemented this recommendation through legislation requiring the FCC to transition additional broadcast spectrum to mobile use through a voluntary incentive auction process rather than traditional FCC mandates.

Among other things, the FCC’s Notice of Proposed Rulemaking initiating the broadcast incentive auction proceeding proposed a “lead” band plan approach and several alternative options, including the “down from 51” approach. An overwhelming majority of broadcasters, wireless providers, equipment manufacturers, and consumer groups rejected the “lead” approach and endorsed the alternative “down from 51” approach. This remarkably broad consensus on the basic approach to the band plan promised to meet the goals of the National Broadband Plan by accelerating the proceeding and motivating voluntary participation in the auction.

That promise was broken when the FCC’s Wireless Bureau unilaterally decided to issue a Public Notice seeking additional comment on a variation of the FCC’s “lead” proposal as well as a TDD approach to the band plan. The Bureau issued this notice over the objection of FCC Commissioner Ajit Pai, who issued a separate statement expressing his concern that seeking comment on additional approaches to the band plan when there is a “growing consensus” in favor of the “down from 51” approach could unnecessarily delay the incentive auction. This statement “peeved” Harold Feld, Senior Vice President at Public Knowledge, who declared that there is no consensus and that the “down from 51” plan would be a “disaster.” As a result, the cooperative process envisioned by the National Broadband Plan is at risk of shifting to the traditionally contentious band plan process that has delayed spectrum auctions in the past.

Consumer groups, including Public Knowledge, acknowledged the consensus

Mr. Feld’s “pique” with Commissioner Pai’s view that the “down from 51” approach had become the “consensus framework” for the 600 MHz band plan is surprising. According to Mr. Feld, Sprint, Microsoft, and the Public Interest Spectrum Coalition (PISC) objected to the “down from 51” approach. As support for this position, Mr. Feld cited reply comments filed by the PISC, a coalition that includes, among others, Public Knowledge.

Contrary to Mr. Feld’s assertion, however, the PISC reply comments  support Commissioner Pai’s view. The PISC reply comments expressly state that there is a “consensus in favor of a 51-down band plan with a duplex gap,” which is “supported as technically superior by virtually all major industry commenters.”

To be sure,  after Commissioner Pai issued his statement, Mr. Feld met with the Wireless Bureau to state for the record that there is no consensus support for the “down from 51” approach. Prior to that meeting, however, Public Knowledge had not expressed that view.

Why has Mr. Feld suddenly become so vehemently opposed to the “down from 51” approach?

“Down from 51” would not reduce revenue

Mr. Feld claims that the “down from 51” approach embraced by the broadcasters and “so many carriers and equipment manufacturers” would be an “absolute disaster” for that very reason – i.e., most of the industry supports it. In Mr. Feld’s view, the fact that the overwhelming majority of industry participants support the “down from 51” approach is evidence that they are “colluding” to reduce auction revenue.

Although the service rules and auction revenue are to some extent interdependent, insofar as band plans are concerned, wireless providers have far greater incentives to promote spectral and operational efficiency than to reduce auction prices. The costs of building and operating wireless networks are significantly higher than the one-time costs of acquiring spectrum at auction, and consumer demand for wireless broadband capacity is rapidly increasing. Given these facts, no rational wireless provider has an incentive to promote a band plan designed to reduce auction revenue.

In any event, Mr. Feld’s theory that the “down from 51” approach could reduce revenue by making too much spectrum available is irrelevant to the band plan issue. Even assuming his theory is correct, the FCC’s other proposed approaches to the band plan, none of which “cap” the amount of spectrum that would be accepted in the reverse auction, would run the same risk. Similarly, Mr. Feld’s proposed solution of limiting the amount of spectrum accepted in the reverse auction could be applied to any approach to the band plan, including “down from 51.”

“Down from 51”  is not anticompetitive

Mr. Feld claims that the “down from 51” approach is anticompetitive because, in his view, wireless providers that lack spectrum below 1 GHz “are the only ones capable of using the downlink spectrum, and even then only if they bid exclusively on the supplementary downlinks.” According to Mr. Feld, this means such providers will bid only on the downlink spectrum and leave the paired spectrum to Verizon and AT&T even though, in his view, providers that lack spectrum below 1 GHz are the ones that “most need” uplink spectrum.

Of course, if this were true, it would be irrational for any wireless provider to join Verizon and AT&T in supporting the “down from 51” approach. Yet, T-Mobile, the only nationwide provider that lacks nationwide spectrum below 1 GHz, is a signatory to the “Joint Accord” supporting the “down from 51” approach, an approach that is also supported by rural and regional providers.

Given the current state of the record, a finding based on Mr. Feld’s hypothesis would require the FCC to assume that wireless providers generally behave irrationally when developing band plans – an assumption so absurd it would fail even the most deferential application of the  Chevron standard for judicial review.

“Down from 51” is not inefficient

Mr. Feld claims the “down from 51” approach is spectrally inefficient because it “maximizes the total number of guard bands” while retaining a duplex gap.

To the contrary, the “down from 51” approach proposed by the FCC would require the  minimum total number of guard bands while retaining a duplex gap: one.

If enough spectrum is cleared to place the guard band adjacent to Channel 37 as proposed by T-Mobile, the “down from 51” approach would also minimize the amount of spectrum that must be allocated to guard bands. This specific version of the “down from 51” approach would require a total of only 4 MHz of guard band spectrum while providing 10 MHz of protection against interference (6 MHz in Channel 37 plus an additional 4 MHz yielded by broadcasters in the reverse auction).

In comparison, the “down from 51 reversed” approach proposed by the Wireless Bureau in the Public Notice would require at least  two guard bands.

If the FCC intends to maximize spectral efficiency by minimizing the total number of guard bands, it will not adopt the “down from 51 reversed” approach proposed by the Wireless Bureau. That is why the FCC proposed to place the 600 MHz uplink band adjacent to the lower 700 MHz uplink band in the “lead” proposal in its Notice of Proposed Rulemaking.

A TDD approach is inefficient

Mr. Feld claims that a “down from 51 TDD” approach would make “maximum use” of spectrum above Channel 37 because it would eliminate the duplex gap required for FDD deployments. He neglects to mention, however, that a TDD approach would require an additional guard band that would be the same or substantially similar in size to the FDD duplex gap in the “down from 51″ approach. Compare the FCC’s “down from 51” approach with the Wireless Bureau’s “down from 51 TDD” approach:

As I’ve noted previously, the switching times inherent in LTE TDD systems also produce latency and reduce coverage – issues that would be exacerbated in rural deployments in the 600 MHz band. LTE TDD operates in two modes: a 10-millisecond mode (more latency, but more coverage) and a 5-millisecond mode (less latency, but less coverage). In the 10-millisecond mode, LTE TDD is generally not suitable for the streaming applications that stress mobile networks the most (e.g., video chat applications). In the 5-millisecond mode, LTE TDD is generally suitable for streaming applications, but suffers from significantly reduced coverage. According to Qualcomm, in a coverage-limited system using the same frequency, TDD requires 31 to 65 percent more base stations than FDD to maintain the same throughput.

This doesn’t mean that TDD technologies have no role to play in the wireless marketplace. In the absence of channel aggregation opportunities, TDD is the only choice when paired spectrum is unavailable. It can also be used to enhance capacity when coverage is not the delimiting factor.

The primary driver behind LTE TDD deployment generally, however, appears to be Chinese industrial policy, not spectral efficiency. After China’s TDD-based SCDMA technology failed to gain traction internationally, it focused its efforts on developing a TDD version of LTE that would be backward compatible with its SCDMA standard and expand China’s technological influence globally. As a result, China became the primary promoter of the LTE TDD standard and a major owner of the standard’s essential patents (i.e., Huawei states that it leads the world in essential LTE patents). Based on likely deployment scenarios in the 600 MHz band, an FCC-mandated TDD approach would benefit Chinese patent holders, not American consumers.

The Public Notice Should Not Have Been Issued by the Bureau

Finally, Mr. Feld accused Commissioner Pai of “poisoning” the rulemaking process by calling attention to the Wireless Bureau’s disregard for his role as a Commissioner. Mr. Feld portrayed the Public Notice as a routine matter, but as a former Chief of the Wireless Bureau, I know that Bureaus do not circulate routine items to the Commissioners. A Bureau typically circulates an item to the Commissioners with a waiting period only when its authority to issue the item at the Bureau-level is unclear. If a Commissioner objects to the issuance of the item at the Bureau level, established practice requires that it be submitted to the Commission for a vote.

In my experience, the Bureau’s decision to ignore Commissioner Pai’s objection was, at a minimum, a serious breach of comity and established protocol. If anything “poisoned” the process in this instance, it was the Bureau’s insistence on issuing a Public Notice on authority delegated to it by the Commission over the objection of a Commissioner.

Conclusion

The surest path to “disaster” in this proceeding is for the FCC to take the incentives out of the incentive auction. The Bureau’s insistence on pushing an approach that most broadcasters, wireless providers, and equipment manufacturers don’t support is more likely to deter participation in the auction than incent it. It is the industry – not the Wireless Bureau – that ultimately must agree to risk its capital in the auction and deploy new wireless infrastructure. If the Wireless Bureau’s preferred approach wins and, as a result, the industry declines to participate in the auction, everyone loses.

This week at CTIA 2013, FCC Commissioner Jessica Rosenworcel presented ten ideas for spectrum policy. Though I don’t agree with all of them, she articulated a reasonable vision for spectrum policy that prioritizes consumer demand, incorporates market-oriented solutions, and establishes transparent goals and timelines. Commissioner Rosenworcel’s principled approach stands in stark contrast to the intellectually bankrupt incentive auction recommendation offered by the Department of Justice last month.

Commissioner Rosenworcel clearly defines three simple goals for a successful incentive auction:

• Raising enough revenue to support the nation’s first interoperable, wireless broadband public safety network;
• Making more broadband spectrum available through policies that are attractive to broadcasters; and
• Providing fair treatment to those broadcasters who do not wish to participate in the auction.

All three goals are consistent with consumer demand for wireless broadband services, the market-oriented reassignment of broadcast spectrum envisioned by the National Broadband Plan, and the will of Congress.

In comparison, the DOJ’s recommendation focuses on only one goal: Subsidizing two particular companies – Sprint Nextel and T-Mobile – to ensure they obtain spectrum in the auction. The DOJ claims these subsidies are necessary to promote competition. But, there is a substantial difference between fair government policies that promote competition generally and a policy of favoring foreign-owned companies over their domestic competitors.

Unfortunately, the DOJ is not alone in its belief that bestowing government benefits on favored companies is a legitimate goal in a free society. Some members of the House Commerce Committee believe the DOJ’s past merger reviews provide “a solid factual and analytical basis” for its current recommendation to the FCC.

The fatal flaw in this theory is that the DOJ’s recommendation to the FCC is inconsistent with the factual findings and analysis of the DOJ in its past merger reviews. As I’ve noted previously, in its complaint against the AT&T/T-Mobile merger, the DOJ found that, “due to the advantages arising from their scope and scale of coverage,” Sprint Nextel and T-Mobile are “especially well-positioned to drive competition” in the wireless industry. That finding doesn’t provide any factual or analytical basis whatsoever to conclude that Sprint Nextel and T-Mobile require special government treatment in the incentive auction in order to compete with Verizon and AT&T.

That’s why the DOJ recommendation relies on an irrational and discriminatory presumption that Verizon and AT&T are using spectrum less efficiently than Sprint Nextel and T-Mobile. A speculative presumption doesn’t require the DOJ to admit its own deceit. It merely requires audacity.

In an era when government officials routinely revise the facts to suit their preferred outcomes and disclaim responsibility for the actions of the agencies they’re charged with leading, Commissioner Rosenworcel’s speech required intellectual bravery and political courage. Her ideas deserve a fair hearing.

The DOJ’s recommendation would likely reduce the amount of revenue produced by the incentive auction and risk leaving the public safety network unfunded (as the economist who led the design of the most successful auction in FCC history will explain in this webinar on Thursday). The unsubstantiated, speculative increase in commercial competition the DOJ says could occur if the FCC picks winners and losers in the incentive auction is a poor justification for continuing to deny our nation’s first responders the network they need to protect the safety of every American.

Beyond enforcing the antitrust laws, the Antitrust Division of the Department of Justice (DOJ) advocates for competition policy in regulatory proceedings initiated by Executive Branch and independent agencies, including the Federal Communications Commission (FCC). In this role, the DOJ works with the FCC on mergers involving communications companies and occasionally provides input in other FCC proceedings. The historical reputation of the DOJ in this area has been one of impartial engagement and deliberate analysis based on empirical data. The DOJ’s recent filing (DOJ filing) on mobile spectrum aggregation jeopardizes that reputation, however, by recommending that the FCC “ensure” Sprint Nextel and T-Mobile obtain a nationwide block of mobile spectrum in the upcoming broadcast incentive auction.

The new “findings” in the  DOJ filing fail to cite any factual record and are inconsistent with the DOJ’s factual findings in recent merger proceedings that contain extensive factual records. The DOJ filing blithely relies on a discriminatory evidentiary presumption to insinuate that Verizon and AT&T are “warehousing” spectrum, and then uses that presumption to support a proposed remedy that bears no rational relationship to factual findings that the DOJ has actually made. The absence of any empirical evidence supporting the relevant conclusions in the DOJ filing gives it the appearance of a political document rather than a deliberative work product crafted with the traditionally substantive and impartial standards of the Justice Department. The FCC, the independent agency that prides itself on being fact-based and data-driven, should give this screed no weight.

DOJ Flip-Flops on Competition in the Mobile Market

The  DOJ filing concludes – without citing any evidence – that Verizon and AT&T have “the ability and, in some cases, the incentive to exercise at least some degree of market power, particularly given that there is already significant nationwide concentration in the wireless industry.” This conclusion directly contradicts the representations of the DOJ in its federal court complaint to block the merger of AT&T and T-Mobile. The companies had argued that the absence of T-Mobile would not have a significant impact on the mobile marketplace because, as a standalone company, T-Mobile faced substantial commercial and spectrum challenges. The DOJ refuted this rationale by finding that, “Due to the advantages arising from their scale and scope of coverage, each of the Big Four nationwide carriers is especially well-positioned to drive competition, at both a national and local level, in this industry.” Now, however, the DOJ asserts that Verizon and AT&T are “dominant firms” in the mobile market and that Sprint Nextel and T-Mobile cannot compete in the upcoming incentive auction unless the FCC adopts laws granting them special privileges. “Each” of the “Big Four” could hardly have been “well-positioned” to “drive competition” if half of them require government subsidies to compete – something I expect the federal court judge would have been interested to hear.

DOJ Recommends a Discriminatory Evidentiary Presumption

After flip-flopping on competition, the DOJ theorizes that Verizon and AT&T could use their “dominant” positions in the mobile market to “foreclose” competition by aggregating excessive mobile spectrum. Rather than rely on actual evidence to support its foreclosure theory, the DOJ  presumes that Verizon and AT&T are not using their spectrum “efficiently” while assuming that Sprint Nextel and T-Mobile could “effectively” make use of more spectrum. The filing concludes – again without citing any evidence – that Sprint Nextel and T-Mobile would make the “highest value use” of new spectrum “absent compelling evidence that the largest incumbent carriers are already using their existing spectrum licenses efficiently and their networks are still capacity-constrained.” The DOJ offered no explanation for its outrageous suggestion that the FCC should hold certain companies to a higher evidentiary standard (a presumption that must be rebutted by “compelling evidence”) than others (for which efficiency is assumed) when evaluating whether they are using their spectrum efficiently.

The DOJ also failed to offer any actual evidence supporting the notion, reiterated in testimony before the Senate Judiciary Committee, that the FCC “take a close look at whether some of the spectrum already available to some providers is being warehoused and not being used.” The FCC established “build out” requirements to ensure spectrum is not being “warehoused” and has previously found that a “single objective metric” of spectrum efficiency is “neither possible nor appropriate.” If the FCC now intends to consider the efficiency of current spectrum use as a factor in developing its spectrum aggregation and auction rules, fundamental principles of justice require that it establish an open and transparent process for defining spectrum efficiency and apply the new metric equally to all mobile providers after a full factual investigation of their actual spectrum use. Among all agencies, one would expect the Justice Department to understand that without a reminder.

DOJ Recommends an Irrational Remedy

The DOJ’s factual flip-flop on competition in the mobile market and its proposed adoption of a discriminatory evidentiary presumption merely lay the predicate for its ultimate policy recommendation: That the FCC distinguish between “low” and “high” frequencies in its spectrum aggregation rules in order to “ensure” Sprint Nextel and T-Mobile obtain a nationwide block of spectrum in the upcoming broadcast incentive auction. In the past, the FCC could simply decree that only Sprint Nextel and T-Mobile are eligible to bid on certain spectrum blocks or to participate in the auction at all. But, based on the disastrous results of previous spectrum auctions that limited the eligibility of certain types of companies to participate, Congress prohibited the FCC from imposing eligibility restrictions on the broadcast incentive auction.

So how does the DOJ propose that the FCC “ensure” Sprint Nextel and T-Mobile are “winners”? Although it cannot directly limit the participation of Verizon and AT&T, the FCC retains jurisdiction to limit the overall amount of mobile spectrum any one provider can hold. Most economists agree that, if a single provider were able to aggregate a significant amount of the total available mobile spectrum, that provider could use its spectrum holdings to engage in anticompetitive behavior. The potential for excessive aggregation of mobile spectrum would not normally be relevant to a particular spectrum auction because the FCC has traditionally treated all spectrum bands the same in this respect. Now, however, the FCC has proposed to apply different rules to “low” frequency spectrum (i.e., frequencies less than 1 GHz) on a nationwide basis – even though the only new mobile spectrum the FCC has proposed to auction in the last five years happens to be the broadcast spectrum, which, coincidentally of course, is below 1 GHz.

In its recent FCC filing, the DOJ is, also coincidentally, recommending this new approach as well, even though its own factual findings don’t support that outcome. Unlike the FCC, the DOJ has traditionally distinguished among mobile spectrum bands below and above 1 GHz, but only in rural areas. After conducting detailed market-by-market analyses in merger proceedings with voluminous factual records, the DOJ found that mobile providers that lack access to spectrum below 1 GHz “generally have found it less attractive to build out in rural areas.” After expressly considering the question in multiple merger proceedings, the DOJ has never considered the distinction between “lower” and “higher” frequency mobile spectrum competitively relevant in urban areas. As it admits in its filing with the FCC, the DOJ considers spectrum above 1 GHz “just as effective as low-frequency spectrum” when a provider “is attempting to augment the capacity of its network in dense urban areas.”

If mobile providers required spectrum below 1 GHz to compete successfully in non-rural areas, the DOJ could not have  truthfully told the federal court that T-Mobile was “well-positioned” to “drive competition” in the mobile market, because T-Mobile has never held substantial “low” frequency spectrum. Despite the fact that T-Mobile has always relied on mobile spectrum above 1 GHz, the DOJ found that T-Mobile managed to build a mobile network covering 90% of the US population and is using that network to compete successfully in the mobile market on a nationwide basis. The DOJ’s factual findings have repeatedly affirmed that, to the extent spectrum below 1 GHz is competitively relevant, its relevance is limited to sparsely populated rural areas where capacity is not a substantial issue. The “spectrum crunch” the incentive auction is intended to ameliorate is a capacity issue caused by the massive growth in data traffic, not a coverage issue, and capacity issues primarily impact areas with high population densities.

The DOJ’s factual findings regarding the competitive relevance of spectrum below 1 GHz would, at best, support a rule limiting the amount of “low” frequency spectrum that a particular mobile provider could hold in low-density rural areas where the distinction between higher and lower frequencies may actually have competitive relevance. Suggesting that the FCC should nevertheless apply such a distinction on a nationwide basis is an irrationally overbroad remedy for potential competition issues that are limited to sparsely populated rural areas when the “spectrum crunch” harms areas with the densest population the most.

It’s also too clever by half in this context. When Congress enacted legislation prohibiting the FCC from imposing eligibility restrictions on the incentive auction, it did so with knowledge that the FCC had not traditionally distinguished among spectrum bands suitable for mobile use. Although the DOJ has recognized a distinction in rural areas during its case-by-case merger reviews, the FCC’s chosen remedy for rural coverage issues has been to mandate by rule that Verizon and AT&T enter into roaming agreements that allow other providers to use their networks, in part because it is often uneconomic for more than one or two providers to build separate networks in areas with low population densities. If the FCC’s findings supporting its roaming orders remain valid, it would presumably be uneconomic for T-Mobile to substantially increase its current rural coverage even if it held spectrum below 1 GHz on a nationwide basis.

DOJ Contradicts Congressional Priorities

Even if “ensuring” Sprint Nextel and T-Mobile “win” spectrum in the incentive auction would prompt those companies to spend the capital necessary to substantially improve their mobile coverage in rural areas (a particularly unlikely outcome for Sprint Nextel, which already holds a nationwide block of spectrum below 1 GHz), picking winners in the incentive auction is inconsistent with Congressional priorities. Among other things, Congress intended that the incentive auction raise $7 billion for the construction of an interoperable public safety network first recommended by the 9/11 Commission Report over a decade ago. The DOJ’s recommendation would likely reduce the amount of revenue produced by the incentive auction and risk leaving the public safety network unfunded (as the economist who led the design of the most successful auction in FCC history will explain in this webinar on Thursday). The unsubstantiated, speculative increase in commercial competition the DOJ says could occur if the FCC picks winners and losers in the incentive auction is a poor justification for continuing to deny our nation’s first responders the network they need to protect the safety of every American. For that reason alone, I expect a thoughtful and independent FCC to reject the politically motivated recommendations of a DOJ that considers itself unaccountable to Congress.

In an important essay this week entitled “Silicon Valley’s ‘Suicide Impulse’,” Wall Street Journal columnist L. Gordon Crovitz warns that “Silicon Valley has long prided itself on avoiding the lumbering relationship between big government and most industries, but somehow it has become one of the top lobbyists in Washington.” Crovitz is worried that Internet and technology companies are falling prey to what Milton Friedman labeled “The Business Community’s Suicidal Impulse”: the persistent propensity to persecute one’s competitors using regulation or the threat thereof. “Rather than lobby government to go after one another,” Crovitz argues, “Silicon Valley lobbyists should unite to go after overreaching government. Instead of the ‘suicide impulse’ of lobbying for more regulation, Silicon Valley should seek deregulation and a long-overdue freedom to return to its entrepreneurial roots.”

Crovitz’s essay touches upon a dangerous trend I have written about here and elsewhere in the past: the increasing politicization of the Internet and information technology sectors and the gradual rise of rent-seeking (i.e., favor-seeking) over time. I’ve written about this problem in essays like:

• “The Sad State of Cyber-Politics” (Cato, 2010)
• “The Troubling Growth of High-Tech Regulation, Lobbying, and Rent-Seeking” (Dec. 2, 2012)
• “On Facebook ‘Normalizing Relations’ with Washington” (March 29, 2011)
• “DC’s LivingSocial Cronyism Experiment Already Going off the Rails” (Nov. 29, 2012)

These essays have documented how tech companies are increasingly vying for the attention of legislators and regulators in Washington, statehouses, and international capitals across the globe.

Why should we care about the increasing politicization of the information technology sector? In a forthcoming Mercatus Center working paper entitled, “A History of Cronyism & Capture in the Information Technology Sector,” Brent Skorup and I explain how “time and resources spent focusing on influencing politicians and capturing regulators represent time and resources that could better be spent competing and innovating in the marketplace. This can negatively impact consumer welfare in two ways: Not only are consumers denied more and better products and services, but they also may pay higher prices or higher taxes extracted by the corporate-government agreement.”

We document how rent-seeking and cronyism have had a corrupting influence on older information sectors and technologies, especially broadcasting and communications. We develop lengthy case studies from each sector to illustrate the costs that rent-seeking imposes on consumers, competitors, and ongoing innovation.

It’s a miserable history but one that is essential to recount if we hope to avoid it for newer sectors and technologies. That’s why Brent and I devote the closing section of our paper to a list of “Strategies to Limit Cronyism” in the Internet world before things get as bad as they have in the communications and media sectors. We argue that it is essential that we use a combination of institutional safeguards and market/social norms if we hope to head-off incessant rent-seeking and avoid the ‘suicidal impulse’ problem that Milton Friedman and Gordon Crovtiz identified.

Generally speaking, we must begin by acknowledging that, as economist David Henderson correctly notes, “There is only one way to end, or at least to reduce, the amount of cronyism, and that is to reduce government power.” Special interest rent-seeking and the chronic cronyism problems of modern America are fundamentally tied up with the constantly expanding horizons of government power. As Mancur Olson taught us in his 1965 book, The Logic of Collective Action, when benefits are concentrated and costs are dispersed (across all taxpayers or ratepayers, for example), we can expect groups to form to take advantage of those benefits. Those groups have a powerful motivation to create, preserve, and perpetuate government programs that favor their narrow interests at the expense of others, while those bearing the true costs of those policies or programs do not have the same incentive (or resources) to lobby government to reduce or end those burdens.

This leads to what economist Gordon Tullock called the “transitional gains trap”: once a policy or program is put in place to favor a certain interest, most of their gains come upfront and are factored into future earnings. Those benefiting from the policies would face large transitional losses if reform is undertaken, even if these policies impose large deadweight costs on society as a whole. This “trap” can frustrate beneficial reform efforts because the interest benefiting from the cronyist policies and programs will fight to the death to preserve them, no matter how costly or inefficient they may be for society as a whole.

There are several steps we can take if we hope to overcome the collective action problem in the tech sector and avoid Tullock’s transitional gains trap.

First, we must limit the scope of technology regulation whenever possible, and where existing rules open the door to cronyism, streamline or eliminate as many of them as possible. When policymakers deregulated other sectors in past—airlines, railroads, trucking, etc.—it helped eliminate the legal levers that industry could capture or influence. Consequently, deregulation forced companies to spend more time satisfying consumers as opposed to lawmakers and regulators.

Second, whenever possible we should rely on auctions and property rights to ensure that resources are being allocated according to market demand instead of political influence. The ugly history of spectrum cronyism is rooted in the misguided reliance upon the so-called “public interest” theory of regulation, which claimed that supposedly enlightened and benevolent regulators would steer resources and markets in more pro-consumer directions. The reality was just the opposite: the “public interest” became synonymous with the private interest of regulated entities, who largely “gamed” the system for their own ends. It was only when policymakers finally embraced the logic of auctions to allocate spectrum that America began to see cronyism dissipate in this sector. Auctions ensured faster allocation and more efficient distribution and development of this important resource. While full-blown spectrum property rights have not yet taken hold, the gradual movement in that direction helps minimize cronyism opportunities.

Third, the use of vouchers can help limit corporate gaming of social programs that are deemed essential. For example, America’s universal service program, which subsidizes phone and now broadband service, is a permanent fixture of communications policy. Unfortunately, cronyism is a permanent fixture of the system as well. Because the universal service system delivers assistance to end-users indirectly through favored local providers, it limits the potential for new entry and undermines competition. A means-tested voucher could have targeted assistance to those who needed it without creating an inefficient, unsustainable hidden tax or undermining competition.

Fourth, sunsetting provisions for new and existing laws and regulations can greatly limit cronyism opportunities. All new technology proposals should include a provision sunsetting the law or regulation within a few years of enactment and existing technology laws and regulations should be reopened and reassessed on a regular timetable as well to ensure they are not being abused. (Here’s a Forbes column I wrote last year with details about how to do so.)

Fifth, we need serious limits on congressional delegations of power to regulatory bodies and executive branch agencies. Too often, lawmakers “pass the buck” on to agencies and expect them to figure out how to interpret and administer arcane technology policy statutes. The result is abuse both by over-zealous regulators and interests looking to game the system. Congress should be more accountable and, at a minimum, must make their regulatory intent and standards clearer before delegating authority.

Finally, we need to encourage better norms inside the tech industry itself and encourage them to hold themselves to a higher standard. We should ask them to promise not to exploit government power that would discourage innovation or crush competition. Better yet, we should ask them to consider “strategic disengagement” with Washington and politics in general. Yes, I understand that sounds like a pipe dream since where power exists interests will likely look to exploit it. And, again, that’s the best reason for serious deregulation and strong limits on government power to begin with. But social pressure and market norms can also help in the absence of more sweeping reforms. Some firms already adopt the right approach. For example, Apple and Sony have largely shunned political engagement and instead focused on satisfying their customers in the marketplace. While their hands aren’t entirely clean, we should encourage more tech innovators to follow their general lead of not sending small armies of lobbyists to Washington and state capitals.

In the end, there is no silver-bullet solution that can forever cure cronyism. It would be foolish to pretend that we’ll be able to significantly curtail the scope of government powers in the short-term. Nonetheless, there are many sensible institutional reforms and marketplace norms that can help us keep cronyism in check before it begins running rampant in this important sector of our economy.

(Brent and I have just sent our paper on this topic off for peer review from some academic experts in this field, but we welcome thoughts from others about strategies to limit and reduce cronyism in this arena. We hope to publish this paper in a law review or poly sci journal later this Summer or Fall.)

Tomorrow the Federal Communications Commission (FCC) is testifying at a House Energy and Commerce Committee oversight hearing on spectrum auctions. The hearing is focused on the implementation of the broadcast incentive auction required by the Middle Class Tax Relief and Job Creation Act of 2012 (“Spectrum Act”), though the members will likely address other issues as well, including mobile spectrum aggregation.

I expect several questions regarding the FCC’s commitment to comply with the legislation as enacted by Congress. FCC Commissioner Ajit Pai has questioned whether several of the agency’s proposals in its auction proceeding are consistent with the Spectrum Act. The FCC’s recent proceeding to consider mobile spectrum aggregation has since raised troubling new questions regarding the agency’s willingness to comply with Congressional directives regarding spectrum auctions. If the FCC adopts new limits on spectrum holdings as suggested by its mobile competition reports, Verizon and AT&T would be prohibited from bidding in the incentive auction. Contrary to Congressional intent, the incentive auction would be rigged before it even begins.

Here is how the FCC could rig the auction in 5 easy steps.

1. Recognize that Verizon and AT&T have substantial mobile spectrum holdings below 1 GHz.
2. Propose an auction of spectrum below 1 GHz.
3. Arbitrarily decide that spectrum below 1 GHz is competitively relevant in both rural and urban areas.
4. Decide that Verizon and AT&T already hold too much (or just enough) spectrum below 1 GHz.
5. Discourage dissent by basing this arbitrary conclusion on highly technical (though arguably irrelevant) “data” that “only an engineer” can understand.

But, didn’t Congress prohibit the FCC from rigging auctions? Mostly. Section 6404 of the Spectrum Act prohibits the FCC from preventing a person from participating in an auction if that person meets the technical, financial, and character requirements to hold a spectrum license. This provision was clearly intended to prevent the FCC from imposing “eligibility restrictions” in an auction. In the past, the FCC had used seemingly neutral eligibility restrictions to pick winners and losers in auctions, though it was the public that lost the most. For example, in the so-called “entrepreneur auction” completed in 1996, the FCC restricted the bidding to certain businesses and allowed them to pay 90% of their winning bids through installment payments. Most bidders defaulted on their payments, and it took nearly ten years to free the licenses from bankruptcy and reassign them to operators capable of providing service to the public. The FCC has lost a total of approximately $26 billion in auction revenue through this and similarly failed policies.

Though Section 6404 was intended to prevent bad results in the incentive auction, Section 6404 has a loophole. It says that the prohibition against eligibility restrictions doesn’t affect “any authority the Commission has to adopt and enforce rules of general applicability, including rules concerning spectrum aggregation that promote competition.” This exception gives the FCC the flexibility to adjust the amount of spectrum that can be held by any mobile provider on a band-by-band basis before every auction. If this flexibility is abused, it could become the exception that swallows the rule.

Congressional oversight will be necessary to ensure the FCC doesn’t use this exception to pick winners and losers in the mobile marketplace. If the FCC intends to distinguish among different spectrum bands when measuring spectrum aggregation, the FCC must do more than examine the  technical characteristics of the spectrum. It must obtain sufficient facts and data to accurately assess the potential impact of distinctions among different spectrum bands on competition – the concern addressed by spectrum aggregation policies. Competition is primarily an economic issue, and competition rules should be based on economic analysis. Until the FCC conducts a rigorous economic analysis of the impact of differences among spectrum bands on competition, if any, it should follow its traditional practice of treating mobile spectrum the same.

Berin Szoka and I just released a short article on the FCC’s proposed follow-up to the failed 700 mhz D Block auction:  a free, nationwide wireless service that would serve public safety users as well as consumers.  It’s attached down below or the PDF can be found here.

What’s Worse Than Rigged Auctions & Internet Censorship? How About Both in One Package!

a PFF Progress Snapshot Release 4.12 June 2008

by Adam Thierer and Berin Szoka

The big spectrum policy debate in town these days continues to be the fight about how to redo the botched D block auction. As we all know, FCC Chairman Kevin Martin’s previous effort to micro-manage that auction failed miserably. Sadly, the follow-up plan isn’t much better, as the Wall Street Journal notes in an editorial today:

You’d think Chairman Martin would have learned from this experience. It’s not the role of regulators to pick winners and losers to achieve their preferred social outcomes. Private competition and the price mechanism can most fairly and efficiently find the best use for scarce spectrum. The FCC’s clumsy attempt at social engineering resulted in a failed auction that has prevented otherwise desirable spectrum from being put to commercial use. Alas, Mr. Martin has now proposed another wireless auction for a separate piece of spectrum. And this time he wants to require the winner to offer free Internet access that filters out pornography–conditions that obviously would decrease the value of the license and turn off potential bidders. It just so happens that Mr. Martin’s proposed auction seems tailor-made for the business plan put forward by M2Z, another politically connected Silicon Valley start-up looking to enter the wireless broadband telecom market.

The declared goal of the new plan is to provide “free” broadband to the masses while also satisfying public safety spectrum needs (though little is understood about how the propose service will support public safety). Supporting legislation introduced by Rep. Anna Eshoo (D-CA), H.R. 5846, the “Wireless Internet Nationwide for Families Act of 2008,” would require the winning bidder to:

offer, at a minimum, always-on wireless broadband services within 2 years from the date of receipt of the license, and complete the construction of such wireless network with a signal covering at least 95 percent of the population of the United States and its territories within 10 years from the initial operation of the network; [and] a data service that is faster than 200 kilobits per second one way for free to consumers and authorized public safety users without subscription, airtime, usage, or other charges.

Good luck getting anyone to bid much on that plan! It’s not really clear why anyone would think that a 200 kbps public utility service–even at zero cost–will have all that much appeal to the masses. Today, through server-side data compression, any of us can already squeeze 300 kbps out of our old dial-up lines–a service now free from companies like NetZero and generally costing less than $10/month. Even most existing wireless data plans today provide greater bandwidth. How many people are really going to want to use a “free” wireless network that pumps out far less? After all, you’re not going to be able to download many videos or big files or do anything very data-intensive on the proposed network. While a certain segment of basic smart phone users might be satisfied with such sluggish speeds for rudimentary web uses such as email, blog-reading, calendars and basic locational searches, existing equipment would not be able to connect to the proposed network because of the bands used. So, while such PDA users might seize the opportunity to use slow-but-free municipal wi-fi networks, they could not use the proposed network: an entirely new generation of wireless technologies would have to be equipped to support yet another wireless standard.

So why would any company pony up serious money at an auction to win the right to provide such a lackluster service to a minimum of 95% of the nation, including costly-to-serve low density areas, within two years? You don’t need to be a Harvard Business School grad to see why that plan doesn’t make much sense for most investors. (Never mind the fact that the auction of this much valuable spectrum with so many regulatory encumbrances will yield far less at auction to the U.S. Treasury.)

Of course, the winning bidder will likely have the right to “up-sell” customers to a higher-speed paid service. But we have no idea how well that plan will work out and, even if it did, it would call into question the logic of rigging this auction in the first place: Is the purpose truly to provide free universal broadband access, or just to hand someone a chunk of somewhat cheaper spectrum to let them up-sell customers to higher-speed, paid plans? If it’s the latter, the plan seems a little unfair to the private carriers who are already aggressively competing in the market today, having paid top-dollar for their spectrum and invested heavily in wireless data networks.

Or will the lucky auction winner be expected to rely in part on advertising revenues to pay for the up-front costs of winning the auction, building out the network and providing service–much as M2Z originally planned to do? If so, the provider would doubtless prefer to offer more profitable behaviorally targeted advertising customized for each user. The Federal Trade Commission has wisely chosen not to regulate such advertising, given its complexities and ongoing evolution, and to rely instead on enforcement of existing unfair and deceptive trade laws, while issuing voluntary guidelines for industry. But of course, the FCC would have jurisdiction over the proposed service and would likely face enormous political pressure to include its own regulatory regime for online behavioral advertising while drafting service rules. The controversy over such rules could delay the deployment of the proposed service, while any FCC regulations would inject the FCC into the ongoing debate over how to govern a practice that provides the revenue stream necessary to support a variety of content and services.

But this new spectrum-rigging plan is troubling for an entirely different reason: It demands Internet censorship. The original M2Z plan included a promise to sanitize this little patch of spectrum to make sure it was “kid-friendly.” What better way to win a spot in the heart of legislators and regulators than to promise network-wide Net filtering! After all, many lawmakers have long considered this the Holy Grail of Internet policy. Eshoo’s bill would mandate such filtering by requiring that the licensee “offer such free data service with a technology protection measure or measures that protect underage users from accessing obscene or indecent material through such service.”

It’s surprising that so few people are discussing the dangers of this portion of the proposal. After all, what we are talking about here is a blueprint for widespread, government-mandated censorship of the Internet. Many folks, including the Wall Street Journal in today’s editorial, seem to be under the impression that the mandate is strictly directed at “pornography”–and nothing more. But Rep. Eshoo’s bill clearly requires filtering of “obscene or indecent material.” Defining obscenity is difficult enough. But including “indecent” content will open up a Pandora’s Box of regulatory shenanigans. One need do nothing more than read a few pages of broadcast regulatory history to appreciate the practical challenge that awaits both providers and regulators as they attempt to monitor the network to ensure that everything is “decent” for the masses. (Moreover, is that really what the Internet that the masses want?)

Regardless, the important question is not what will be censored, but how it will be censored–a critical detail that neither Chairman Martin nor Rep. Eshoo have spelled out. But, in all likelihood, we’re talking about something more that just downloadable filters for consumers to install themselves if they so chose–leaving the decision to individuals and parents, where it belongs in a free society. Instead, it seems clear that we are talking about server-side, network-wide filtering that will essentially be forced on all users of the network. Such a technological solution will greatly slow down the already primitive network being proposed under this plan. But, more importantly, we have to wonder what sort of precedent is being established here for other broadband networks and the rest of the Net.

Of course, policymakers will respond by saying that the plan is simply another regulatory quid pro quo: We rig the auctions to drive down the cost, and you, the winning carrier, clean up the Net for us. That’s all easier said than done, and it raises a host of constitutional issues in the process. There are many better ways to protect kids, and there are certainly better ways to run a spectrum auction.