Top Economist Slams US Telco Prices

Joseph Stiglitz (pictured) is a Nobel prize-winning economist known for his work on risk aversion and for his critique of free markets. When a man like Stiglitz finds fault with with the way telcos charge for services then decision-makers should pay attention. Stiglitz is not just an intellectual, but also a popular and influential thought leader. The average voter may not have heard of Stiglitz, but politicians will know who he is. So we should pay attention to Stiglitz’s indictment of US telcos in a recent article for The Nation. However, whilst I cannot claim to be an internationally-respected academic, it seems to me that Stiglitz’s theories about the factors that drive high US telco prices are undermined by several serious mistakes and misconceptions.

Stiglitz’s central argument is about the extent to which monopolists are strangling the US economy and its people. The first example he cites is indicative of where he expects public sympathies to lie.

There is a widespread sense of powerlessness, both in our economic and political life. We seem no longer to control our own destinies. If we don’t like our Internet company or our cable TV, we either have no place to turn, or the alternative is no better.

Stiglitz gives other examples of monopolistic practices, like the prices of drugs, but clearly Stiglitz recognizes there is widespread dissatisfaction with ISPs and cable providers in the USA. Drawing on his examples, he argues that the US has not done enough to curb abusive pricing.

…it became almost impossible to successfully bring a predatory pricing case: Any attempt to raise prices above costs would instantaneously be met by an onslaught of new firm entry (so it was claimed). Chicago economists would argue—with little backing in either theory or evidence—that one shouldn’t even worry about monopoly: In an innovative economy, monopoly power would only be temporary, and the ensuing contest to become the monopolist maximized innovation and consumer welfare.

Over the past four decades, economic theory and evidence has laid waste to such claims and the belief that some variant of the competitive equilibrium model provides a good, or even adequate, description of our economy.

There may be limitations with the economic models that Stiglitz is attacking, but surely he is oversimplifying the arguments of his opponents. The regulations that govern US telecommunications are both complicated and convoluted because it has long been recognized that you cannot deliver effective competition – or nationwide coverage – by expecting every telco to run multiple lines to every home. Telecoms networks tend towards being natural monopolies. Suppose the consumer had to pay the full price for the investment needed to attach a physical line to their home. How bad would their service have to be for the consumer to choose to pay full price for a second line from a rival provider?

There has been an increase in the market power and concentration of a few firms in industry after industry, leading to an increase in prices relative to costs (in mark-ups). This lowers the standard of living every bit as much as it lowers workers’ wages.

This may be true in general, but how does it relate to the example that Stiglitz begins with, which was about electronic communications? Nobody had a mobile phone 30 years ago. The deployment of new radio network infrastructure, and the supply of all the other equipment and services necessary for mobile telephony, resulted in millions of American homes obtaining a second line, separate from the landline they previously depended upon. And unlike the landline, the invisible lines created by radio signals mean customers have an individual connection to the network. The connection follows the customer wherever he or she goes. Instead of the household sharing a single line – and arguing about who has been hogging it for too long – every adult, and most older children, possess a separate phone with a unique number. Far from seeing a concentration of market power, the recent history of telecommunications has involved a great improvement in the standard of living and a massive expansion in the number of suppliers that customers could turn to.

Supporters of Stiglitz may feel my observation is irrelevant, because Stiglitz’s example was narrowly about ISPs and cable companies. But a quick review of history shows that Stiglitz’s point about increased concentration leading to increasing prices cannot apply to ISPs or cable companies either. We cannot look back at some golden past where people had several like-for-like physical electronic network connections to their home. The number of network connections to the home is rising, not falling. The cable company that first connected to a person’s home may have merged with another, thus reducing nominal choice in their particular market. However, the overwhelming problem with the market is that physical connections cannot be cheaply switched on and off like a radio signal.

A key driver of increased prices in the US communications market is the reduction of historic subsidies to consumers. The only way to make money from the capital investment needed to deploy new connections and network capacity is to entice as many customers as possible by offering a low initial price to encourage increased take-up. This approach leads to losses in the short run, and only generates profits in the long run. Investors broadly understand this model. The dotcom boom allowed a lot of finance to be poured into network infrastructure because investors were prepared to forego dividends in exchange for the promise of rising share prices. They effectively traded a small but certain amount of jam today for the promise of much more jam in future. That exchange is no longer attractive for telcos, and dividends have risen as a result. Now investors want cash today, because they do not believe telco shares are guaranteed to climb in future. So businesses that previously burned cash by spending more on infrastructure than they received in revenue must now generate free cashflow from customers. That leads to M&A activity when weaker comms providers cannot satisfy their shareholders.

With all this in mind, we should also reflect on the narrowness of Stiglitz’s argument. In the history of the human race, the internet is new. Cable television is new. Mobile providers are new, and offer a choice, whether the customer’s goal is access to the internet or watching a film. Currently some choices are poor – mobile bandwidth is limited – but that is because of the amount that has so far been spent on the improved technology and infrastructure that businesses continue to develop. However, the existence of multiple means to consume the same type of service offers a counterargument to the belief that choice inevitably declines without government intervention. VHS tapes had some disadvantages compared to cinemas, but they still resulted in a new and different way to consume films. So why does Stiglitz hold up ISPs and cable companies as examples of anti-competitive trends that reduce the quality of life, when a few decades ago cinemas and TV broadcasters faced competition from neither?

Stiglitz is using telcos as a convenient bogeyman for his general-purpose argument about the concentration of wealth and power. Maybe his overarching argument is generally right, but the telecoms example he prefers is a sop to ill-informed public opinion, even though the dynamics of a capital-intensive but highly technological market represents a poor fit to Stiglitz’s analysis of wider economic concerns about regulation. But you may think I have exaggerated the extent to which Stiglitz is relying on one example. However, he keeps coming back to the US telecoms market as his bête noire:

Is there any reason why US telecom prices should be so much higher than in many other countries and service so much poorer? Much of the innovation was done here in the United States. Our publicly supported research and education institutions provided the intellectual foundations. It is now a global technology, requiring little labor—so it cannot be high wages that provide the explanation. The answer is simple: market power.

Excuse me, but the Nobel laureate’s argument is garbage. One simple but widespread observation about the price and quality of telecommunications services is that they are related to population density. So immediately there is a reason for high prices that has nothing to do with market power. The USA is a big country, but is not heavily populated for its size. In the USA there are 86 people living in each square mile, on average. South Korea has 1,329 people per square mile. So whilst league tables tend to fixate on the tremendous speed of networks in South Korea, there is a tendency to ignore a key advantage enjoyed by Korean telcos compared to their international peers. Economists appreciate the relationship between population density and telecoms services, which is why telco regulators focus so much effort on engineering subsidies and incentives for the delivery of services in rural areas. So Stiglitz’s argument is disingenuous for ignoring such an important and well-documented factor relating to price and quality.

Stiglitz instead notes that much of telecoms innovation occurred in the USA. It is hard to see why the location of the innovation should confer an advantage in terms of price or quality. American companies may have innovated, but Chinese companies can make the same network technology at lower cost. The location of the innovation is irrelevant if somebody elsewhere has learned how to do the same thing more cheaply. If anything, the cost of services in the US has been driven up by government rules that block Chinese firms from selling to US telcos. Stiglitz makes no mention of the US ban on Chinese telecoms tech, though it is pertinent to the issue of pricing by US telcos.

The more we look at Stiglitz’s argument about economics, the more we see he has no understanding of the relevant technology, or of what happened in the telecoms sector. What good is an intellectual ‘foundation’ in the USA if your European rivals all cohere around a single GSM standard whilst American telcos adopt several standards that cannot work together? Japan went down the same dead end as the Americans, and they also suffered longer-term consequences as a result. I believe Stiglitz is blinded by the success of several internet businesses that originated in Silicon Valley, leading him to adopt a typically insular American view of how to measure ‘success’ in the telecoms market.

A big problem with the US market is that the pricing efficiencies pursued elsewhere are difficult to achieve in a country which adopted a uniquely cumbersome series of wholesale pricing rules. Stiglitz writes about the international nature of technology but completely misses the point about what that means in practice. The countries best placed to take advantage of international capability are the ones which freely import it from wherever it is cheapest, and which most closely adhere to international norms. The USA is neither, having developed a contrived market which outsiders find difficult to comprehend. That is a one important reason why techniques like revenue assurance are relatively backward in US telcos. Whilst telcos elsewhere saw a need to make marginal operational efficiencies relating to their retail revenues, the equivalent techniques in the USA were diverted into the need to check wholesale prices and to stop a multitude of intercarrier frauds that only make sense in the context of US regulations.

Globalization was supposed to lead to a more competitive market place, but instead, it has provided space for the growth of global behemoths, who use their market power to extract rents from both sides of the market place, from small producers and consumers. Their competitive advantage is not based just on their greater efficiency; rather, it rests partly on their ability to exploit this market power and partly on their ability to use globalization to evade and avoid taxes. Just five American firms, Apple, Microsoft, Google, Cisco, and Oracle, collectively have more than a half trillion dollars stashed abroad as they achieve tax rates in some cases well under 1% of profits.

Stiglitz’s argument here is interesting for several reasons, but the most profound is that he has painted a picture of globalization that is flatly contradicted by the experience of the US telecoms market he singled out for criticism. Some US telcos are amongst the biggest in the world, but whilst massive multinational groups have originated in several regions, none have started life in the USA. Africans, Arabs, Asians and Europeans are all familiar with multinational telco groups. It would not even occur to the average US citizen that the ‘T’ in T-Mobile might be spelt as ‘telekom’, because their market is so inward-looking.

Part of the problem with Stiglitz’s all-encompassing macroeconomic analogies is that the tactics adopted by firms like Apple and Google cannot be replicated by telcos who need to implement physical infrastructure where the customer actually is. So whilst Stiglitz cites US telco prices as proof of his thesis about the failure of national government power, they mostly look like a contradiction to it. Government and regulatory control of comms networks has led the US to put a lot more ink on a lot more paper than any other country, and their telcos have little ambition beyond the country’s borders, but Stiglitz is arguing the solution to current problems is to devote more ink to more paper to further increase national control.

A key fault of Stiglitz’s analysis is that he offers both telcos and data-hoarders like Google as examples of the same market dysfunction. On the contrary, the two kinds of business are natural enemies. Nobody can collect data using the internet if the customer is not connected using some actual physical network infrastructure. A market that is biased because of the power of telcos would allow telcos to charge the most they could from everybody they could – and that would mean choking Google for as much money as possible. In contrast, a market that is biased by Google’s power would allow the data gatherers to enjoy a free ride that is paid for by others. And that is exactly how the current US market works, to the advantage of Google. So once again Stiglitz identifies a market inefficiency that is working against US telcos whilst asserting the problem is the lack of government intervention in the market, when Google’s free riding is possible because the US government effectively barred ISPs from charging firms like Google for wholesale use of the internet. This skew towards big business means the US telecoms market must generate a disproportionate amount of revenue from the retail consumers at the other end of the line from Google.

The more you break down the economic arguments surrounding telcos, the more they seem to be based on conflicting and unjustified analogies that simply do not apply to the realities of how the telecoms market has and does work in practice. But bashing telcos is in vogue. No matter how incoherent, the narrative promoted by Stiglitz, and echoed by politicians, is telcos suffer the same faults as other big businesses, even when there circumstances are diametrically opposed.

I actually agree with Stiglitz that the prices of services in US telcos are too high, but his diagnosis of the causes does not fit the facts. US telcos could certainly learn a lot from international peers that have been forced to innovate in ways that US telcos have not. Telcos in developing nations that work on much leaner margins are willing to find efficiencies that seem to be of little interest to US telcos. I suspect this is key to the relatively impoverished market for RAFM services in the US. On a bigger scale, the profits being generated from the domestic market mean US telco execs have less motive to expand overseas. Stiglitz has only the most superficial understanding of how telcos outside the USA can deliver better and cheaper services than those experienced in the USA, but I suspect his myopia is representative of wider issues in the US market. Though Stiglitz observes that some innovation occurred within the USA, perhaps the real problem is a reluctance to learn from success stories experienced elsewhere.

You can read Stiglitz’s article for The Nation by following this link.

Eric Priezkalns
Eric Priezkalns
Eric is the Editor of Commsrisk. Look here for more about the history of Commsrisk and the role played by Eric.

Eric is also the Chief Executive of the Risk & Assurance Group (RAG), a global association of professionals working in risk management and business assurance for communications providers.

Previously Eric was Director of Risk Management for Qatar Telecom and he has worked with Cable & Wireless, T‑Mobile, Sky, Worldcom and other telcos. He was lead author of Revenue Assurance: Expert Opinions for Communications Providers, published by CRC Press. He is a qualified chartered accountant, with degrees in information systems, and in mathematics and philosophy.