Spectrum Trading in the United Kingdom: Considering
Market-Based Liberalization from Two Perspectives
Proefschrift
ter verkrijging van de graad van doctor aan de Technische Universiteit Delft,
op gezag van de Rector Magnificus prof.ir. K.C.A.M. Luyben, voorzitter van het College voor Promoties,
in het openbaar te verdedigen op dinsdag 20 mei 2014 om 15:00 uur
door Rajendranath Janki AKALU
Master of Laws, London School of Economics, United Kingdom geboren te Bristol, United Kingdom
Dit proefschrift is goedgekeurd door de promotor: Prof. dr. J.P.M. Groenewegen
Samenstelling promotiecommissie:
Rector Magnificus, voorzitter
Prof. dr. J.P.M. Groenewegen Technische Universiteit Delft, promotor Prof. Dr. W.H. Melody Aalborg University, Denmark
Prof. dr. M.J.G. van Eeten Technische Universiteit Delft Prof. Dr. L.E. Doyle Trinity College Dublin, Ireland
Dr. V. Dutraive University Lumiére-Lyon, France
Dr. Ir. W. Lemstra Aalborg University, Denmark
Professor Dr. C.P. v. Beers Technische Universiteit Delft, reservelid
Funding provided by Next Generations Infrastructures Foundation Next Generation Infrastructures
Acknowledgements
Radio spectrum is a unique form of social property that is born out of an innate human desire to communicate. Understanding radio spectrum in the course of my PhD has been
intellectual odyssey; one that has challenged and changed me and caused me to grow both in courage and humility. This journey began in Toronto at the Centre for Innovation Law and Policy (CILP) at the University of Toronto Faculty of Law. I have Richard Owens, former director of CILP to thank for giving me my start in academia. The Centre’s former librarian Sooin Kim (aka “Creasy”) has been a great friend to me. While at the Centre I met Dr. William Melody. His 1980 article Radio Spectrum Management: Role of the Market had a profound influence on me. I followed Bill to Denmark to work as his research assistant. I would like to thank former colleagues at the Demark Technical University (DTU) Center of Information Communications Technologies (CICT), in particular Dr. Iwona Windekilde former office mate and Dr. Andrius Butkus, former roommate in Valby as well as Bill’s wife Merete. I left Denmark for Ireland and had a wonderful time working at the Commission for Communications Regulation (ComReg). Special thanks to Jim Connolly, Dr. Samuel Ritchie, Claire Kelly and former ComReg Commissioners Isolde Goggin and Etain Doyle. I learned much about the practical aspects of radio spectrum management during this time. I left ComReg for TU Delft. I thank my Promotor Dr. John Groenewegen and co-promotor Dr. Wolter Lemstra. It is no understatement to say that their supervision has refined my research and polished my character; this thesis is better and I am a better person because of them. I thank Dr. Julia Trombetta with whom I also shared an office for her helpful suggestions. Dr. Helmut Leonard and Andre Arts of Agentschap Telekom always provided helpful feedback as did Peter Anker. I would also like to thank my stand-up comedy mentor Dr. Martijn Jonker for preparing me for my stand-up performance in Amsterdam. Thanks also to my paranynphs Daniel Scholten and Emiel Kerpershoek as well as Prisca Koelman. A special thank-you to my former roomie Adriana Diaz Arias; we had the best time at our beautiful flat Brabanste Turftmarkt 53. During that time we shared an amazing cat Fidel (aka “Mimi”) who sadly passed away. Mimi was like our spoiled (furry) child. He certainly inspired me and is greatly missed. I returned to Canada and I have Dr. Ann Cavoukian to thank for hiring me at the Information Privacy Commission (IPC Ontario). I left the IPC for my current position at the Faculty of Business and Information Technology at the University of Ontario Institute of Technology (UOIT). I thank Dean Dr. Pamela Richie and Associate Deans Dr. Jenifer Percival and Steve Rose for supporting my appointment. Other Professors support, encouragement and intellectual inspiration on my journey include Dr. Deepa Kundur at the University of Toronto, Dr. Andrea Slane, UOIT, Dr. Ha Joon Chang, University of
Cambridge, Dr. David Moss, University of Harvard, Dr. Daniel Bromley, University of Wisconsin and Dr. Malcolm Rutherford, University of Victoria. I would like to thank my parents the late Sookdeo Akalu and Savita Akalu, my siblings Toni and Emily as well as my in-laws Dr. Jagat and Mrs. Seeta Singh and brother-in-law Kevin soon to be Dr. Kevin Singh M.D. I would also like to thank my long-time friend Bernhard Damian. And last (but not least) to my wife Jenny: Thank-you for your love and support and for our beautiful children Landon and Annabelle.
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Table of Contents
1. The market-based liberalization of communications infrastructures ... 11
1.1 Introduction ... 11
1.2 Research question and research plan ... 15
1.3 The spectrum resource ... 17
1.3.1 Spectrum Management ... 23
1.3.2 International Radio Spectrum Allocation ... 23
1.3.3 Regional Radio Spectrum Allocation ... 24
1.3.4 National Radio Allocation and Assignment ... 25
1.4 Case study: The policy of liberalization via spectrum trading in the U.K. ... 25
1.5 Structure of research ... 27
2. The Market as Objective Approach ... 31
2.1 Introduction ... 31
2.2 Neoclassical Economics ... 32
2.3 New Institutional Economics ... 37
2.4 Conception of institutions in NIE ... 43
2.5 Analytical objectives in NIE ... 44
2.6 Operational characteristics of the MO approach ... 44
2.7 Conclusion ... 45
3. The Market as Tool Approach ... 47
3.1 Introduction ... 47
3.2 Original Institutional Economics ... 49
3.3 Conception of institutions in OIE ... 53
3.4 Analytical Objectives of OIE ... 56
3.5 American Pragmatism ... 58
3.5.1 Reasons for action ... 59
3.5.2 What we claim to know ... 59
3.5.3 What constitutes an explanation ... 61
3.5.4 The impossibility of objective descriptions of possible outcomes in the future ... 61
3.5.5 Truth ... 62
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3.6 Operational characteristics of the MT approach ... 66
3.7 Conclusion ... 66
4. Case Study: Spectrum Trading, U.K... 71
4.1 Introduction ... 71
4.2 The situation prior to the introduction of spectrum trading ... 72
4.3 The Cave Report ... 74
4.4 The legal framework for spectrum trading ... 76
4.5 Spectrum trading by license category ... 80
4.5.1 Business radio ... 80
4.5.2 Spectrum access ... 84
4.5.3 Concurrent spectrum access ... 84
4.5.4 Broadband fixed wireless access – Scanning telemetry ... 85
4.5.5 Fixed services ... 86
4.5.6 Public wireless networks ... 86
4.5.7 Trading in each of the license categories ... 90
4.6 Conclusion ... 93
5. The MO approach applied to the U.K. ... 95
5.1 Introduction ... 95
5.2 Coase’s Central argument ... 96
5.3 Coase as applied by subsequent proponents of the MO approach ... 98
5.4 The MO approach applied to the U.K. case ... 101
5.5 Conclusion ... 103
6. The MT approach applied to the U.K. case ... 105
6.1 Introduction ... 105
6.2 The market as an institutional tool of spectrum policy ... 107
6.2.1 Interpretations of the historical record ... 111
6.2.2 A market type system with prices... 113
6.3 The MT approach and the U.K. case ... 114
6.3.1 Assessment dimensions ... 120
6.3.2 Business Radio ... 121
6.3.3 Spectrum access ... 125
6.3.4 Concurrent spectrum access band – Fixed wireless access ... 126
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6.3.6 Fixed services – Fixed links ... 129
6.3.7 Public wireless networks ... 130
6.4 Hypotheses that explains spectrum trading in the U.K. according to the MT approach ... 132
6.5 Conclusion ... 134
7.1 Comparing the MO and MT approaches ... 137
7.1 Introduction ... 137
7.2 Epistemic Communities ... 138
7.3 MO/MT as epistemic communities ... 139
7.4 How the MO/MT approaches explain the U.K. case ... 142
7.5 The impact of the MO/MT approaches on the U.K. policy ... 144
7.6 Conclusion ... 144
8. Conclusion: Radio spectrum allocation: Role of the Market (Revisited) ... 149
8.1 Introduction ... 149
8.2 Recommendations based on the MO/MT approach ... 151
8.3 When to use the MO/MT approach in spectrum policy reform ... 153
8.4 How the MO and MT approaches can work together – A plea for pluralism ... 154
8.5 Further research ... 155
8.6 Conclusion ... 156
Appendices ... 159
A. Research Interview Questions ... 159
B. Response – Senior Ofcom Representative ... 162
C. Response – Fiachra O’Doherty ... 169
D. Response – Peter Anker ... 172
Abbreviations ... 177
Bibliography ... 179
Samenvatting in het Nederlands ... 189
viii Figures and Tables
Tables
Table 1 Typical radio frequencies, band name and applications ... 20
Table 2 Williamson’s four layer model ... 42
Table 3 Transactions and their various dimensions ... 51
Table 4 Types of trading that can occur for license sectors in the U.K. ... 79
Table 5 Business Radio License Types ... 83
Table 6 Assignment of spectrum for 4th Generation mobile networks ... 90
Table 7 Cave’s suggested reasons for lack of trading in the U.K. ... 102
Table 8 Alternatives for the use of markets as a spectrum reform measure ... 114
Table 9 Spectrum Trading U.K. (Trades recorded in TNR 2004-2013) ... 133
Figures Figure 1 Simplified Wireless Communications Diagram ... 19
Figure 2 Growth in Telecommunications and the use of Radio Spectrum ... 22
Figure 3 Structure of Research ... 28
Figure 4 Williamson’s Simple Contracting Scheme ... 40
Figure 5 Modes of Spectrum Trading ... 78
Figure 6 Technologies use in the UHF band ... 87
Figure 7 Number of trades that have occurred in the U.K. since trading began in 2004 ... 92
Figure 8 DeVany Spectrum Reform Proposal ... 99
Figure 9 Model of Spectrum Management ... 108
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Chapter 1 The market-based liberalization of
communications infrastructures
1. The market-based liberalization of communications infrastructures
1.1 Introduction
The desire to communicate is a basic imperative of the human condition. Communication forms the basis of expression and defines to a considerable extent what it means to be human.1 It is therefore unsurprising that human beings have developed sophisticated technologies of communication. As such communication has been regarded as “the central phenomenon of society” (Wiener 1950: 229). And as Wiener observes, “[p]roperly speaking, the community extends only as far as there extends an effectual transmission of information” (Wiener 1948: 184). Modern advances in communications technologies have enabled considerable social, economic and political development in practically all countries.
Communications technologies require access to the telecommunications infrastructure. This infrastructure, which can consist of both wired and wireless technologies form the backbone of modern economies. The global interconnected nature of this system has resulted in a sociological transformation which has come to be termed network societies (Castells 2011). That these developments have impacted economic development is well documented. Expanding the telecommunications network generates cost savings in relation to other markets (Crocioni 2009; Dholakia and Harlam 1994; Hardy 1980; Leff 1984). In a study of twenty-one OECD countries over a twenty year period Röller and Waverman found a positive causal link between investment in the telecommunications infrastructure and
economic development. They conclude that “[a]s the telephone system improves, the cost of doing business falls, and output will increase for individual firms in individual sectors of the economy” (Röller and Waverman 2001: 910).
The telecommunications infrastructure is an example of a network industry. Other network industries include electricity, gas, railways, airlines etc. Markets for products and services in these industries can be distinguished from markets for individual products and services in other sectors (e.g. the dairy industry or legal services) by the following four characteristics (Shy 2001). First, network industries are characterized by complementarity, compatibility and standards. The term complementarity implies that consumers are buying systems
composed of complementary components (e.g. hardware and software) rather than individual items that can be consumed alone (e.g. cheese). Complementary components must work
1 For an account of the evolutionary processes that explain the origins of the psycho-social underpinnings of
human co-operative communication see M. Tomasello, Origins of Human Communication (Cambridge, MA: The MIT Press, 2008).
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together (i.e. must be compatible) and this requires a degree of co-ordination. Common standards are required in order to ensure interoperability between system components. GSM (Global System for Mobile, originally Groupe Spécial Mobile), is an example of a well-known standard for mobile telephony. The standard was developed by the European Telecommunications Standards Institute (ETSI) to describe technologies for second generation (2G) digital cellular networks. The GSM standard permitted wide-ranging compatibility between mobile handset manufacturers and network operators.2 Second, network industries are characterized by consumption externalities associated with the size of the network. This implies that the utility derived from consumption of network industry goods is affected by the number of people using compatible products. Mobile phones, fax machines and email became more valuable as their use became widespread. A third
characteristic of network industries is that of switching costs and lock-in effects. This refers to the cost of switching to an alternative service provider which can be considerable in some cases.3 Lastly, network industries are characterized by significant economies of scale in production. There are for example high fixed costs associated with deploying a
telecommunications network infrastructure, but low marginal costs associated with adding additional subscribers to that network.
Network industries tend to have dominant entities (incumbents) that capture most of the market. Before 1984 it was accepted that the network utilities of gas, telecoms and electricity should be organized as vertically integrated monopolies centred on, and justified by, the natural monopoly of the network (Newbery 2004). In the telecommunications industry vertical integration meant that utility providers made their own telephones, telephone cables, telephone exchange equipment and other supplies. The regulatory paradigm associated with vertical integration changed as a result of a shift in US anti-trust policy which resulted in the divestiture of the American Telephone and Telegraph Company (AT&T)4. The fundamental theory underpinning the break-up of AT&T was termed the “Bell Doctrine” by Baxter (Baxter 1983). Baxter argued that regulated monopolies have the incentive and opportunity to monopolize related markets in which their monopolized service is an input. To remedy this problem, ownership and control should be separated from the potentially competitive segments of the network. This would prevent the regulated monopoly from abusing its dominant position. The Bell Doctrine, theoretically applies to a variety of other industries where incumbent, vertically integrated, regulated monopolies control both monopoly segments and potentially competitive segments (Joskow and Noll 1998).
2 The GSM Association estimates that the technologies that defined the GSM standard serves 80% of the global
market, encompassing more than five billion people across more than 212 countries and territories, making GSM the most ubiquitous of the many standards for cellular networks.
3 For an informative discussion of the various types of lock-in classifications found in network economies see C.
Shapiro and H. Varian, Information Rules: A Strategic Guide to the Network Economy (Harvard Business Press, 1999).
4 See United States v. AT&T. The settlement for this case was actually filed as United States v. Western Electric
Co., 569 F. Supp. 990 (D.D.C. 1983), which modified the 1956 settlement of United States v. Western Electric Co., 1956 Trade Cas. (CCH) 68,246 (D.N.J. 1956), and so this case is also referred to as the Modified Final
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Similar policy developments followed in Europe through the European Commission and the publication of the Green Paper on the Development of the Common Market for
Telecommunications Services and Equipment in 1987.5 The paper called for an ambitious general reform of the regulatory framework. These reforms aimed at promoting competition in network industries. This in turn raised questions concerning how best to design regulatory mechanisms such that incentives for efficiency are increased and the costs of regulatory obligations are minimized (Ceriani et al. 2009). Competition was expected as a result of the liberalization of network industries which permitted private individuals and corporations to participate in the wider economic and governance activities from which they were previously excluded (Ogundimu 2003). The idea prevailed that the privatization of public monopolies constituted a prior and necessary condition for market-based liberalization of network industries. The main justification for this prescription is that privatization in developed market economies is needed to promote efficiency (Ceriani et al. 2009). Privatization would impose budget constraints and cost reflective pricing, increasing competitive pressures that would otherwise be unlikely in a vertically integrated incumbent monopoly provider that was typically a state-owned incumbent. This resulted in the belief that more market, more competition and less government would lead to increased efficiencies. Subsequently, the infrastructure would be offered to consumers at lower prices and the production processes, as well as the products, would be more innovative due to the pressure of competition
(Groenewegen 2005). The literature on the design of markets in the effort to liberalize network industries is particularly well developed (Arrow et al. 2008; Coles et al. 2010; Roth 2008; Wilson 2002). While the market design literature is considerable, our experience in considering the outcomes of liberalization remains limited. Given the decision to go down the path of liberalization and the fact that the process of liberalization has been taking place for some time, it has become increasingly necessary for us to reflect on the successes and failures of the policy of liberalization in network industries. This is of immediate practical relevance given the important role network industries play in practically all countries.
This thesis focuses on a policy of market-based liberalization in the wireless communications infrastructure, referred to as the radio spectrum. The radio spectrum is a subset of
electromagnetic waves lying between 3 kilohertz and 300 gigahertz.6 The radio spectrum supports a wide range of communication purposes that include business, personal, industrial, scientific, medical and cultural activities, in both the public and private sector (Cave and Foster 2010). The radio spectrum is regarded as a finite resource due to the effects of signal interference.7 As such the radio spectrum was historically allocated for particular uses and assigned to particular users by administrative processes (Akalu 2007). However as the users and uses of spectrum increased8, a range of proposals aimed at introducing economic criteria
5 COM(87) 290, June 1987.
6 The number of oscillations per second is called frequency, which is measured of units of Hertz. The term
kilohertz and gigahertz refers to thousands and billions of Hertz respectively.
7 The ITU Radio Regulations, Art. 1.666 define interference as: “The effect of unwanted energy due to one or
more combination of emissions, radiations or inductions upon reception in a radio communications system, manifested by any performance degradation, misinterpretation or loss of information which would be extracted in the absence of such unwanted energy.”
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into the administrative processes associated with the allocation and assignment of radio spectrum were advanced (Cave 2002; Coase 1959; Crocioni 2009; Hazlett 1998; Herzel 1951; Rosston and Steinberg 1997; Rosston and Hazlett 2001). A centralized spectrum administration was viewed as being vulnerable to political corruption and unable to have a detailed knowledge of demand and supply trends, technological developments and the
relative value to society of alternative services (Cave 2002). Regulatory agencies came to the “belief that firms have the best knowledge of their own cost preferences and a strong
incentive to respond to market signals and put resources to their best possible use” (Ofcom 2004: 4).
One of the main proposals to facilitate these market-based reforms has been to create a market in freely transferable spectrum rights intended to substitute the administrative allocation process.9 The rationale for a market system in spectrum rests on the role of property rights in the efficient allocation of resources. A fundamental requirement of such a market in spectrum is that property rights must be defined and privately transferable (Hatfield and Weiser 2006; Melody 1980). In a 1980 article in the American Economic Review titled: ‘Radio spectrum allocation: role of the market’, Melody argued that given the essential characteristics of radio spectrum and the divergence between social and private valuation of wireless technologies, economic criteria should facilitate rather than replace spectrum
administration. This is because “[t]he objective of the spectrum administration process is not simply to imitate a market, or adopt economic valuations that a market might yield” (Melody 1980: 393). Melody concludes that “the market is one of the many tools for policy analysis. It cannot, and most certainly will not be the policy objective” (Melody 1980: 397).
This closing remark by Melody suggests that there are two perspectives to be taken when discussing markets in relation to the radio spectrum administrative processes. The first is to regard markets as the policy objective of the administrative process. This may be referred to as the market as objective approach (the MO approach). The MO approach implies that an efficient resource allocation will result from the introduction of markets. In the second approach the market is used to facilitate rather than replace spectrum administration and is therefore referred to as the market as tool approach (the MT approach). When introducing economic criteria in spectrum administration Melody contemplates developing relations between economic and non-economic objectives of the administrative process through the use of theories of economic rent and common resource management.10 Melody does not however explain why there is a difference in these two approaches, the relationship between them and the implications of taking one approach over the other. These nuances, as we shall see, are related to the interpretative communities (known as epistemic communities) that support the MO and MT approaches.11 As will be shown, proponents of the MO approach
9 Other proposals to introduce market-based reforms that are not discussed in this thesis include auctioning
spectrum licenses, establishing shadow prices for spectrum assignments or exchanges or administrative incentive pricing.
10 For a discussion of economic rent theory and spectrum allocation see R. Akalu, 'Opportunity Costs and
Spectrum Reform', info, 9/6 (2007), 3. For a discussion of spectrum administration and common resource management see P. Anker, Ph.D. thesis (forthcoming).
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essentially regard radio interference as an externality. The argument made here is that the ‘social cost’ associated with harmful interference should be internalized by firms through private bargaining. Proponents of the MT approach by contrast characterize radio spectrum as a unique natural resource. This being the case we are required to consider these unique attributes when proposing change to the existing 'working rules' associated with radio spectrum management. In this thesis it is argued that the approach taken on markets directs the way in which reform issues are framed analyzed and resolved. This thesis examines how the two perspectives on markets consider the outcomes of a particular form of market-based liberalization. The aim of this thesis is not however to settle the debate about which approach is ‘correct’ in any definitive sense, but rather explore what is meant by ‘the market’ as
understood by the two perspectives and the problem that the market is expected , and can be expected to solve in relation to a particular network industry. Such a study can facilitate policy reform when markets are being proposed as well as develop the theoretical insights that underpin such proposals. A concrete case is needed to explore the two approaches. From this we can determine how the case material fits, illustrates and confirms the two approaches and the implications that this has for policy reform of radio spectrum when trading is being proposed. We consider for this purpose the policy of liberalization of radio spectrum via spectrum trading in the U.K.
1.2 Research question and research plan
This thesis examines the policy of liberalization via spectrum trading in the U.K. through the lenses of two perspectives on markets. This research therefore investigates:
How is the outcome of the policy of liberalization via spectrum trading in the U.K. considered through the lenses of two perspectives on markets: the MO and MT approach?
The objective of this research is to understand the outcome of events following a policy of market-based liberalization in a specific network industry. This is done in a manner that utilizes both approaches in an effort to further policy reform. In so doing we may highlight the advantages and limitations associated with the MO/MT approaches and guide future policy reform when market-based liberalization is being proposed. It should be noted at the outset that not all countries have attempted to engage in market-based liberalization via spectrum trading. The U.K. is a useful case study as it has been a strong proponent of market-based liberalization of radio spectrum and notably spectrum trading since 2004. Moreover, the U.K. spectrum trading policy developed from a common E.U. regulatory framework that applies to all 27 member states.12
Case studies are a preferred strategy in social science when ‘how’ and ‘why’ questions are being posed. They are especially helpful when the researcher has little or no control over events and when the focus is on a contemporary phenomenon within some real-life context
12 Directive 2002/21/EC of the European Parliament and of the Council of March 7, 2002 on a common
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(Yin 2009). Naturally, case studies are “limited in their generalizability, creating the danger that results are time, sector, and country specific. However when they are used to
contextualize key points of an explanation, and the explanation and not the cases, carries the argument, case studies can be very powerful” (Nightingale et al. 2003: 479). And as
Flyvbjerg notes, “[t]he advantage of the case study is that it can ‘close in’ on real-life situations and test views directly in relation to phenomenon as they unfold in practice” (Flyvbjerg 2006: 235). In this way case study material can result in the revision of preconceived views, assumptions, concepts and hypotheses (Ragin and Becker 1992; Wieviorka 1992). Examining the U.K. as a single case rather than studying multiple cases permits us to revise what has been referred to as the ‘casing’, that is the delimitations of the case. In making consistent analyses across multiple cases, the subtleties of an individual case would invariably be lost. It is more difficult to explore the boundaries of the case with
multiple case studies because these will need to be standardized. As a result the “fluidity of the casing is a special feature of small-N research and explains why small-N qualitative research is most often at the forefront of theoretical development (Ragin and Becker 1992: 225). Examination of the U.K. case is undertaken with reference to both the MO and the MT approach.
As our research question suggests the MO and MT approaches, frame, analyze and resolve the issues associated with spectrum reform differently. These differences and their
implications for spectrum policy reform will be explored at length in this thesis. From this presentation we derive a number of characteristics that have to be operationalized in order to apply them to the U.K. case. In its operationalized form, when the MO approach is applied to the U.K. case we will be able to interpret the events following the process of liberalization and then fold this analysis back into the design of better policy. When the operational characteristics of the MT approach are derived and subsequently applied to the U.K. case our analysis will necessarily be hypothetical since, there is insufficient data to provide a complete analysis using the MT approach.13 However the application of the MT approach can also further reform since it can clarify our understanding of spectrum trading when used as a tool of policy.
A central challenge in this research is to highlight the outcomes of liberalization in our chosen network industry case in order to illustrate the explanations offered by the MO and MT approaches. To accomplish this task this thesis first discusses how the MO and MT approaches are connected to the prior literature on Institutional Economics (IE). In IE, “the explanandum is the institution. Definitions of institution refer to a framework of behaviour: institutions direct, channel or guide behaviour” (Groenewegen et al. 1995: 467). The analysis of institutions is directed toward better understanding the performance of firms, markets, and economies in different settings. However, as we shall see, markets, when explored as institutions, are approached from different perspectives in the literature on IE. The MO and MT approaches are shown to be connected to different schools of IE respectively referred to as New Institutional Economics (NIE) and Original Institutional Economics (OIE). With this understanding in place, the two approaches are formulated into operational characteristics to
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be later applied to the U.K. case. Next, the policy of liberalization via spectrum trading in the U.K. and the present outcomes associated with this policy are discussed. We will then apply the MO and MT approaches to the U.K. demonstrating how this discussion is related to the academic literature on spectrum trading. We can then reflect on the policy recommendations that flow from taking the MO or MT approach in order to highlight the possibilities for further research and practical applications.
Formulated as research sub-questions this thesis is structured as follows: The MO and MT approach
How is the MO and MT approach connected to the prior literature on IE?
What are the operational characteristics of the two approaches? (Chapters 2 and 3) The U.K. case
What was the regime of spectrum management prior to the introduction of spectrum trading? (Chapter 4)
What objectives did the policy of liberalization via spectrum trading in the U.K. seek to accomplish? (Chapter 4)
Application of the MO and MT approaches and recommendations
How are the outcomes of the policy of liberalization via spectrum trading in the U.K. considered in the MO approach? (Chapter 5)
How are the outcomes of the policy of liberalization via spectrum trading in the U.K. considered in the MT approach? (Chapter 6)
What recommendations do the two approaches offer to further the reform of spectrum policy when trading is being proposed? (Chapters 7 and 8)
1.3 The spectrum resource
To provide the necessary technical insights for a discussion of the MO and MT as it applies to the governance of the radio frequency spectrum, we start with a summary description of the radio frequency spectrum as the resource under consideration. Radio waves are a form of electromagnetic radiation that propagates in space as a result of oscillating electric and magnetic fields. In this regard radio spectrum shares attributes similar to natural resources. However radio spectrum is a resource of communication as its main use is the act of sharing information between a transmitter and receiver (Smythe 1981). Radio spectrum is used for communication by encoding information into a radio wave. This is achieved by varying the basic characteristics of the electromagnetic wave in relation to the input stream such as voice, data or multimedia, a technique referred to as modulation. Modulation causes the radio waves to be spread across a range of frequencies. This range is referred to as a radio frequency propagation channel. The input data stream is then transmitted as a signal by means of a radio antenna in the specified band (Sudakshina 2010). In order for
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received. Reception requires the signal to be distinguished from external energy fluctuations or the ‘noise floor’. The noise floor is the sum of all unwanted energy emissions in relation to the transmitted signal (ITU 2004). Electromagnetic or thermal noise cannot be eliminated and must be accounted for. The ratio of signal to noise must be within acceptable limits in order to ensure system performance and allow communication between the transmitting and receiving device. The transmitted data stream can then be demodulated and recovered by the receiving device. The figure below provides a simplified diagram of a wireless
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Figure 1 Simplified Wireless Communications Diagram
(Adapted from Hodgkinson 2007: 12) It is important to appreciate that different radio waves have different propagation
characteristics. Radio frequencies are not homogeneous. Generally speaking, lower frequencies carry signals further and provide for low data rates (or information carrying capacity). Higher frequencies by contrast support higher data rates and require a line of sight. This results in different parts of the radio spectrum being used for different technological applications. Some typical radio frequencies, their physical characteristics and applications are illustrated in the table below.
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Table 1 Typical radio frequencies, band name and applications Frequency 9 kHz 30 kHz 300 kHz 3000 kHz 30 MHz 300 MHz 3000 MHz 30 GHz 300 GHz Band
Very Low Frequency Low Frequency Medium Frequency High Frequency Very High Frequency Ultra High Frequency Super High Frequency Extremely High Frequency Not designated
Example use Long distance radio Naval broadcast
Aeronautical communications Sound broadcasting
Private business radio TV broadcasting Radar
Broadband wireless access
(Adapted from Cave 2002: 43) The amount of information that can be encoded in a radio wave is related to the signalling technique used. As a general rule, there are two types of signals: Analogue and digital. Analogue signals are continuous such that some time varying feature of the signal is a representation of some other time varying quantity (e.g. a human voice). While analogue signals have theoretically infinite resolution, they are irreparably degraded by system noise (Sudakshina 2010). This is to be contrasted with digital signalling. Here the original information is converted into a binary string of information before being transmitted. The advantage with digital signalling is that it can be regenerated without irreparable degradation. Digital signals can also be compressed allowing more data to be transmitted in the same frequency band. Digital signals transmit data (e.g. voice, video or text) in a common format allowing the information to be rendered on a variety of platforms (e.g. personal computers, mobile devices and televisions). The digitization of radio networks has resulted in a technological trend commonly referred to as ‘convergence’ (Mueller 1999). Regardless of the signalling technique used, radio waves experience a loss of intensity or field strength the further the geographical distance from the transmission source. This phenomenon is known as attenuation or path loss (Hodgkinson 2007). When multiple transmitters are introduced interference effects must be accounted for. Interference occurs when two transmitters operate at the same time, frequency range and geographic proximity such that the receiving device is unable to distinguish between concurring signals (ITU 2004). Interference is considered problematic to the extent that it is ‘harmful’ to other legitimate spectrum users. Thus in a technical sense, interference results in a condition of scarcity since all transmitting devices may not simultaneously transmit in exactly the same way.14 That said, radio spectrum is
14 Citing a US National Research Council report on wireless technology Benkler suggests that the model of
interference is no longer useful as a way of ‘optimizing wireless communications systems.’ He explains that “[i]f a thousand transmitters transmit, the ‘waves’ don’t destroy each other, no information is destroyed. The only thing that happens is that it becomes harder and harder for the receivers to figure out who is saying what to whom as more transmitters operate next to each other. The limitation, or real economic scarcity , is computation and the (battery) power to run calculations.”Y. Benkler, 'Open Wireless Vs. Licensed Spectrum: Evidence from Market Adoption', Working Paper, (2011) at 3. It should be noted that this argument relies on wireless devices
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depletable and self-renewing; transmission interference ceases immediately once radio transmitters are not in use. Most other natural resources are depletable. In the case of soil, water and air, renewal may take millions of years and mutate via the food chain (Smythe 1981). Because radio spectrum is used to transmit information and because the control of information is the basis of political power, the control and the use of radio spectrum is closely aligned with the sovereign interests of nation states (Smythe 1957). As spectrum is
extensively used by both the public and private sector as a transmission medium of communication, its liberalization has considerable political and economic significance (Arnbak 1997; Cave et al. 2007; Melody 1980). The spectrum is regarded as ‘scarce’ in that it is not possible to give all who want in all they desire at zero cost (Aitkin 1994). However the capacity for the spectrum as a transmission medium of information has increased as new technologies have become available. This has afforded greater access to users as well as enabled more data to be transmitted relative to the amount of bandwidth used. The diagram below shows the increased uses of the spectrum resource over a 100 year period.
being ‘smart’ meaning they are able to detect each other and transmit on different frequencies when required. However as Lansford has noted: “[u]nfortunately, the benefits from device-centric spectrum management [as opposed to policy-based spectrum administration] are only fully realized when all devices in a frequency band are cognitive, so they can negotiate.” J. Lansford, 'U.W.B. Coexistence and Cognitive Radio', Ultra Wideband
Systems, 2004. Joint with Conference on Ultrawideband Systems and Technologies. Joint UWBST & IWUWBS. 2004 International Workshop
(Austin, TX: IEEE, 2004), 35-39 at 36. This being the case, spectrum management policies that involve exclusive license arrangements remain necessary. These arrangements are based on an interpretation of spectrum scarcity that is premised on interference and thus interference remains important to our discussion of the MO and MT approach and is used in this thesis.
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Figure 2 Growth in Telecommunications and the use of Radio Spectrum
(ePolicy 2011) The more recent innovative technologies that are improving the capacity of the spectrum resource may be grouped into four categories:15 The first of these is spread spectrum. These are technologies that code and send the carrier signal over a range of frequencies. Direct sequencing spread spectrum, spreads the carrier signal over a wide frequency range.
Frequency hopping spread spectrum can occupy the same frequency range but uses a narrow signal that hops from one frequency to another following a specified sequence. These are both examples of ‘overlay’ technologies. A particularly successful example of spread spectrum is Wi-Fi, also referred to by its standard IEEE 802.11 (Lemstra et al. 2010). Ultrawideband (UWB) is an example of an ‘underlay’ technology. UWB operates by transmitting precisely timed pulses across a very wide range of frequencies, several GHz in bandwidth. The pulses represent the ones and zeros of digital communication. The receiver then translates the pulses into data by recognizing familiar pulse sequences sent by the transmitter (Siwiak and McKeown 2004). This allows transmission at high data rates allowing the communication to be transmitted across a range of frequencies below the noise floor. A second technology is sectorized (or smart) antennae. These devices send and receive more focused transmissions lowering potential interference. Examples of these include switched beam antennae (that can adjust sensitivity of transmission to a sector where the receiver is located) and adaptive array antennae (which can dynamically track the user and transmit the signal to an actual position) (ITU 2004). Thirdly, software defined radio (SDR) offers the potential for computer programmed transmission and reception. A type of SDR that has attracted considerable interest is cognitive radio. This technology can track the
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user’s environment over time and space with respect to the use of other radio frequencies (Mitola and Maguire Jr 1999). Lastly, mesh (or collaborative gain) networks operate on the principle that each device located on the network can simultaneously connect and
communicate with all devices within its range. This can provide a cost-effective and robust way of expanding network access (ITU 2004).
1.3.1 Spectrum Management
In order to coordinate the allocation of specific uses and assign rights to specific users of the radio frequency spectrum a degree of centralized co-ordination (also referred to as ‘command and control’) was required (Smythe 1957). This resulted in scarcity in an institutional sense since the granting of exclusive rights to access the resource meant that not all potential wireless users could be accommodated. The notion of institutional scarcity is noted by Aitkin who states, “[s]carcity is an elusive concept when applied to radio spectrum for on the one hand there are ultimate limits set by the laws of physics and on the other hand there is an artificial scarcity necessarily created by human institutions (i.e. previous allocation and assignment conditions)” (Aitkin 1994: 686). The processes of spectrum assignment and allocation are collectively referred to as spectrum management. According to Bauer, spectrum management seeks to address three interrelated problems:
The allocation of the correct amount of spectrum to certain uses or classes of uses The assignment of the correct amount of spectrum to certain classes of users The adjustment of these allocations and assignments as technologies and markets
evolve over time (Bauer 2002: 118).
Due to the wide ranging communication applications of the spectrum resource, spectrum management takes place at three governmental levels – global, regional and national. 1.3.2 International Radio Spectrum Allocation
At the global level the International Telecommunications Union (ITU) allocates radio frequencies through the issuance of Radio Regulations which have treaty status among the organizations’ 193 member states. The ITU maintains a frequency table that allocates the radio spectrum internationally. As a general rule, these allocations typically do not specify a particular technology or application to be used but rather they stipulate generic classifications that may share the allocated spectrum (e.g. the allocation of ‘mobile service’ includes paging as well as public and private mobile telephony).16 The ITU provides a harmonizing
framework for wireless applications requiring global operability. It divides the world into three regions for the purpose of managing radio spectrum globally. Each region has its own frequency allocation that is consistent with the overall framework.
16 A notable exception to the general rule of generic allocation by the ITU is spectrum allocated for 3G mobile
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Region 1 – Europe, Africa, the Middle East (west of the Persian Gulf and including Iraq), the former Soviet Union and Mogolia.
Region 2 – the Americas and some of the eastern Pacific Islands.
Region 3 – most of the non-former Soviet Union Asia east of and including Iran and most of Oceania.
As part of its mandate the ITU issues ITU-R Recommendations which are intended to be advisory rather than mandatory. ITU Recommendations do not have treaty status as is the case with the Radio Regulations however radio spectrum administrations regard these recommendations as authoritative and so they are widely acknowledged and implemented in practice.
1.3.3 Regional Radio Spectrum Allocation
Within the broad ITU radio allocation framework regional arrangements for allocation also exist. This occurs even when radio services are not intended for pan-regional operation as there are advantages for users, manufacturers and regulators in harmonizing frequency usage and radio frequency regulatory regimes (Maitra 2004). In Europe regional cooperation is undertaken by the Electronic Communications Committee (ECC) and the Conference of European Posts and Telecommunications Administrations (CEPT) which provides detailed guidance to the national regulatory authorities (NRAs) of member states. CEPT membership includes central and eastern European countries and consists of 48 member states. The European Telecommunications Standards Institute (ETSI) develops the harmonized
equipment standards that facilitate interoperability among network equipment and devices. This work forms part of a broader European Union mandate that seeks to promote an open and competitive digital economy through the development of pan-EU systems and services for which spectrum availability should be secured (Akalu 2006; Barendse 2006; Radaelli 2007; Rodrigues 2009).
The EU has engaged in significant regulatory efforts in order to facilitate spectrum harmonization by its member states. For example the EU Radio and Telecommunications Terminal Equipment (R&TTE) Directive 1998 for example ensures interoperability across the EU member states without the need for separate national regulatory approval. All equipment placed on the market to which the Directive applies must adhere to the requirements of the R&TTE Directive which provides for user health and safety, electromagnetic emission levels, the mitigation of interference etc.17 In addition to this specific Directive, the more general provisions of the Framework Directive18 state that allocation and assignment of radio frequencies by NRAs should be based on objective, transparent, non-discriminatory and proportionate criteria. Similarly, the EU Authorization
17 Directive 1999/5/EC of the European Parliament and of the Council on Radio Equipment and
Telecommunications Terminal Equipment and the mutual recognition of their conformity (R&TTE Directive).
18 Directive 2002/21/EC of the European Parliament and of the Council of 7 March 2002 on a common
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Directive19 specifies the circumstances under which the granting of individual licenses is allowed and limits the conditions that may be attached to rights of use for radio frequencies. In the Americas regional cooperation is achieved by the Inter-American Telecommunications Commission (CITEL) and in the Asia-Pacific region, the Asia Pacific Telecommunity (APT). 1.3.4 National Radio Allocation and Assignment
NRAs make allocations based on national conditions. Once the allocation decisions are made, NRAs assign specific radio frequencies to individual users. Radio licenses provide exclusive access to individual users and more importantly afford them interference protection from other users. The discretion on the part of NRAs to manage spectrum in this way is based on the notion that each nation has the jurisdiction over radio waves within its own territory. However all nations must accede varying degrees of their sovereignty in this regard in order to effect global wireless communications (Smythe 1957). If for example a state wishes its citizens to make use of satellite or maritime services, reciprocal arrangements must be made with other states in order to make this possible. In the case of satellite, the
transmission footprint cannot be targeted to affect citizens in one country without spillover into another (Fossa et al. 1998). In the case of maritime services, equipment must be
standardized in order to be interoperable globally (IMO 2012). This limits the capacity of any single NRA to act independently of other states as there is a mutual interest in having cross border two way communications.
1.4 Case study: The policy of liberalization via spectrum trading in the U.K.
Having discussed the physical characteristics of the radio spectrum and outlined in broad terms the general regulatory regime associated with spectrum management, we may now briefly consider the specific policy reform of spectrum trading as implemented by the U.K. Office of Communications (Ofcom). The U.K. spectrum trading regime allows certain holders of spectrum licenses to transfer or lease spectrum usage rights to another party. In the past spectrum was primarily assigned on a first come first served basis. When demand for frequencies in a given band exceeded supply for a given service a decision was made not to allocate additional spectrum. The remaining limited number of licenses available would be awarded on a competitive basis. Potential licensees were now required to participate in a comparative selection process (also referred to as ‘beauty contests’) based on criteria
established by the NRA. These criteria included bidder qualification, technical proposals for frequency use, project plans etc. (O.E.C.D. 2005). In some countries this process was vulnerable to political intervention and corruption. Moreover, as key segments of the radio spectrum became congested, the number and complexity of license applications lengthened (O.E.C.D. 2005). In order to mitigate the perceived weaknesses of assignment by
comparative selection, a few NRAs experimented with price auctions to assign spectrum. However, in designing an auction judgement on the part of the NRA is required to determine
19 Directive 2002/20/EC of the European Parliament and of the Council of 7 March 2002 on the authorization of
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the amount of spectrum to be allocated, the geographical coverage of the license, the license duration as well as its technical specifications (Klemperer 2002). Notwithstanding the merits of auctions as a primary assignment mechanism, there is still a requirement to make
subsequent re-assignments as new technologies emerge. These new technologies may or not require access to the resources pursuant to the terms previously granted to the now incumbent licensees. It would not be feasible to make subsequent re-assignments via auctions since an exclusive constellation of access rights to make use of the spectrum would now be privately held by parties who now would have a legitimate expectation to be compensated in order to divest their entitlements.
In order to remedy this problem the U.K. government commissioned Martin Cave to
undertake an independent review of spectrum management in the U.K. The ‘Cave Report’ as it became known, recommended that the Government undertake a policy of selective
deregulation of spectrum use where possible within the U.K. and argue in international fora for increasing reliance upon the market rather than administrative systems for the
management of spectrum (Cave 2002). In recommending spectrum trading Cave stated: Spectrum trading is the most significant step towards a market-based spectrum management regime. It offers great potential benefits to spectrum users, enabling them to enter the wireless market and develop a service by purchasing access to the spectrum they need when they need it. This in turn should bring benefits to
consumers from innovation, greater choice and competition. It should also ease Ofcom’s task, by devolving many complex commercial judgements to the market to resolve, and opening up telecommunications and broadcasting networks to greater competition (Cave 2002: 18).
Cave argued in his report that the ability for NRAs to devise procedures to ration current and future access to spectrum between competing commercial and public services is no longer tenable as this would require a central administration that had a detailed knowledge of demand and supply trends, technology developments and the relative value to society of alternative services. This he argued is well beyond the scope of any regulatory agency (Cave 2002). By forcing users to face continuing incentives towards more productive uses of the spectrum resource, spectrum would be priced as any other input in the productive process. Price signals about the cost of using spectrum would then be disseminated throughout the economy. This would enable dispersed economic agents to make their own judgements about their use of spectrum and the alternatives open to them in order to meet their own
organizational goals (Cave 2002). The Cave Report was later endorsed by Ofcom which subsequently issued a consultation paper outlining its views on how spectrum should be managed (Ofcom 2004). In that document, Ofcom states its position on the use of markets in spectrum management:
We believe that market forces should be allowed to prevail where this is in the best interests of citizens and consumers. This is based on the belief that firms have the best knowledge of their own costs and preferences and a strong incentive to respond to market signals and put resources to their best possible use (Ofcom 2004: 4)
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It should be noted that the focus of this thesis is not with ‘market forces’ in a general sense. Market forces or market mechanisms as it is sometimes referred, includes the design of the primary market and can include auctioning the spectrum or administrative incentive pricing where owners of frequency usage rights pay recurring license fees (Doyle 2004; Webb 1998) but rather the more specific market-based policy of spectrum trading. As stated by Cave above spectrum trading was regarded as the ‘most significant step toward a market-based administrative regime’ since it devolved many complex commercial judgements for the market to resolve. It should also be noted that the focus is on market-based liberalization and not technical liberalization. A term frequently used in the context of this form of
liberalization is ‘technological neutrality’. The term implies that regulations neither impose nor discriminate in favour of the use of a particular type of technology (Webb 2009). However, while seeking to introduce flexibility of any kind into a licensing regime, there are technical assumptions associated with interference and spectrum efficiency. The assumptions made in the decision making process will invariably reflect judgements concerning the technologies that are going to be deployed in that band. Since spectrum trading does not occur in all bands the bands that have been selected are arguably the ones deemed most suitable for spectrum trading and are thus the focus of the present study.20 This is because our research question is limited to considering the outcome following a process of liberalization via spectrum trading with reference to the MO and MT approaches. Finally, this research does not consider wired communications as an alternative form of communication in order to argue for the ‘best’ use of the radio spectrum; this would unnecessarily complicate the illustration of the two approaches. Our goal will be to show how considering the two approaches can guide spectrum policy makers when a specific form of market-based liberalization is being proposed.
1.5 Structure of research
In the next two chapters the MO and MT are outlined and their connection to prior literature on IE is shown. Chapters 2 and 3 respectively will conclude with operational characteristics of the MO and MT approaches. In chapter 4 the policy and outcomes of liberalization via spectrum trading in the U.K. is outlined. Chapter 5 will apply the MO approach to the U.K. case and chapter 6 will apply the MT approach to the U.K. Chapter 7 compares the two approaches showing the MO and MT approaches as epistemic communities that interpret market-outcomes in particular ways. Chapter 8 reflects on the main research question and the objective of this thesis. The implications of these findings are explored in an effort to guide future policy reform when market-based liberalization via spectrum trading is being
proposed. Suggestions for further research are also discussed in this chapter.
20 These bands relate to licenced categories specified by Ofcom. These categories are: Business radio,
concurrent spectrum access, broadband fixed wireless access, fixed services, spectrum access and public wireless networks. The specific details of these categories are provided in chapter four.
28 Figure 3 Structure of Research
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Chapter 2 The Market as Objective Approach
2. The Market as Objective Approach
2.1 Introduction
In this chapter we present the first of two perspectives on markets that Melody remarked upon in his 1980 paper: ‘Radio spectrum allocation: role of the market’(Melody 1980). In this first perspective the creation of markets is regarded as the policy objective since its aim is to adopt economic valuations of spectrum that a market might yield. The creation of freely transferable spectrum rights is thought of as a substitute for the administrative allocation process. This perspective is referred to as the market as objective approach (the MO
approach) as it implies that an economically efficient spectrum resource allocation will result from the introduction of markets (i.e. spectrum trading). To understand how this claim is made, the prior literature on institutional economics (IE) as it relates to the MO approach is reviewed. IE is a broad type of economic analysis that encompasses a wide range of
analytical methods (Chavance 2008). According to the MIT dictionary of economics, IE is “a type of economic analysis which emphasizes the role of social, political, and economic organizations in determining economic events” (Pearce 1992: 209). Medema notes that a “defining element of institutionalism may be said to be its emphasis on the importance of institutions in determining the structure and evolution of economic activity” (Medema 1996: 53). Central questions of IE are “why institutions come into existence, why they develop in specific ways, and what can be said about their efficiency?” (Groenewegen et al. 1995: 467). These questions are explored in different ways by the two main schools of IE: New
Institutional economics (NIE) and Original Institutional Economics (OIE)21(Coase 1998a; Furubotn and Richter 2005; Hodgson 1993; Langlois 1989; Rutherford 1995; Williamson 1975). The schools differ with respect to their problem definition (explanandum), their explanatory variables (explanantia) and their methodology of inquiry (Groenewegen et al. 1995). Within these two divisions there is considerable diversity. The two schools differ as we shall see in their analytical objectives and conception of institutions. Their application to policy making as the MO and MT approaches will be shown to have different operational characteristics. In this chapter we are focused on NIE as developed out of the work of Coase, Williamson, North, Ménard and others (Ménard and Shirley 2005).22
21 OIE is sometimes referred to as “old” institutionalism. This terminology implicitly suggests that NIE is an
improvement on the old. This thesis uses the term ‘classic’ or ‘original’ institutionalism instead of the more common, but perhaps misleading term old to describe this form of institutionalism. For discussion of this terminology see M.R. Tool and P.D. Bush, Institutional Analysis and Economic Policy (Springer, 2003).
22 In the next chapter we will discuss OIE. It should be noted that the work of North though associated with NIE
is in many respects closer to OIE, see J. Groenewegen, F. Kerstholt, and A. Nagelkerke, 'On Integrating New and Old Institutionalism: Douglass North Building Bridges', Journal of Economic Issues, 29/2 (1995), 467-75.
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Both NIE and OIE can be viewed as alternate responses to the limitations of neoclassical economics (NCE). NCE is a body of economic theory that studies a set of market prices which ensured equality of supply and demand (Samuelson and Nordhaus 2001). In NCE, efficient outcomes are assumed pursuant to the conditions of perfect competition. NCE and how it relates to NIE and OIE serves as a useful reference point to distinguish between the MO and MT approach. An understanding of NCE will help illustrate the differences in explanandum, explanantia and methodology of inquiry between the MO/MT approaches. This will in turn play an important role when the two approaches are later applied to the policy of spectrum liberalization via trading in the U.K.
What is illustrated in this chapter is that NIE extends NCE while retaining core elements of NCE namely efficiency as an organizing principle. The focus of NIE is on the explanation of institutions with reference to the utility maximizing individual placed in a well-specified environment which produces an efficient outcome. In this chapter it is demonstrated that when the market is discussed as an institution in NIE the market is viewed as being both a governance structure and an anonymous selection mechanism of actors and their economic activities. The governance structure refers to an institutional matrix within which
transactions are negotiated and executed (Groenewegen et al. 1995). When the institutional structure is ‘right,’ actors are expected to select efficient modes of governance to coordinate transactions of spectrum. But the process by which selection takes place is not well
explained in NIE. Taking its cue from NCE, the market in NIE is regarded as an anonymous selection mechanism of actors and their economic activities. With well-defined laws
concerning the exchange of property, prices will reflect the relative scarcity of a given resource and an efficient outcome will result. We therefore begin our discussion of NIE by presenting NCE.
2.2 Neoclassical Economics
The term neoclassical economics means different things to different people so it is helpful to provide an account of the core attributes of the theory.23 NCE has been described as “a sparse model of maximizing behaviour in the face of competition and constraints” (Boyer and Smith 2001: 212). Central to NCE is the axiom of rational behaviour represented analytically by the technique of constrained maximization (Groenewegen et al. 1995). Latsis formulates the NCE research program’s into the following propositions:
“(i) Decision-makers have correct knowledge of the relevant features of their situation.
(ii) Decision-makers prefer the best available alternative given their knowledge of the situation and the means at their disposal.
However Williamson is regarded as the leading proponent of NIE. C. Ménard and M.M. Shirley, Handbook of
New Institutional Economics (Kluwer Academic Pub, 2005).
23 For a discussion of the historical development of the term see T. Aspromourgos, 'On the Origins of the Term
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(iii) Given (i) and (ii), situations generate their own internal ‘logic’ and decision-makers act appropriately to the logic of their situation.
(iv) Economic units and structures display stable, coordinated behaviour.
The positive heuristic of the programme may be expressed in the following maxims: (i) ‘Construct static models’
(ii) ‘Minimize and if possible completely eliminate psychological and , in general, non-economic content from the model’
(iii) ‘Setup the situational assumptions in such a way that a determine equilibrium issues.’ (Set up “single-exit” situational models).
(iv) ‘Where possible construct functions which are suitable for the application of the procedure of the calculus’.
(v) ‘If the model yields no determinate equilibrium, modify the situational assumptions until such a solution becomes possible’.
(vi) When the model yields a determinate equilibrium, attempt to refine it by introducing more realistic situational assumptions’. (italics in original)(Latsis 1976b: 22-23).
Latsis continues: “ The ‘protective belt’ of a research programme is developed by the clash of the research programme’s structural components (‘hard core’ and ‘positive heuristic’) with its major anomalies. The protective belt consist of various types of propositions from specific auxiliary hypotheses for predictive failure, to redefinitions of the conceptual apparatus” (Latsis 1976b: 22).
For the perfectly competitive model this means:24 a. Profit maximization
b. Perfect knowledge
c. Independence of decisions d. Product homogeneity e. Large numbers f. Free entry and exit25
Profit maximization refers to the seller’s motive to maximize the difference between total cost and total revenue. Since producers can switch instantaneously to other more efficient combinations of production factors and consumers can switch instantaneously to new products, prices transfer the relevant information required to make a purchasing decision. In this sense, NCE assumes perfect knowledge and perfect prices and this in turn renders
24 The hard core refers to the ‘descriptive hard core’ (specification of the fundamental characteristics) and the
normative hard core, or ‘positive heuristics’ (a set of imperatives on how the programme should be applied). As Latsis states: “Adherents of the neoclassical programme usually seek protection against apparent empirical discrepancies by claiming that the discrepant situation did not fully satisfy the conditions of applicability of the theory. For instance, it is pointed out that, contrary to what we supposed, adjustments are bound to be slow and that it is only in the ‘long run’ that perfect competition comes into its own.” S.J. Latsis, 'Situational Determinism in Economics', The British Journal for the Philosophy of Science, 23/3 (1972), 207-45 at 212.
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determinate the results of profit maximization. The independence among economic agents is necessary for a competitive market since if they can affect each other’s behaviour there is not a ‘level-playing field.’ The perfectly competitive market is characterized by NCE’s hard core and auxiliary assumptions since “[u]nder the conditions characterizing perfect competition the decision maker’s discretion in choosing among alternative courses of action is reduced simply to whether or not to remain in business” (Latsis 1972: 209). The auxiliary
assumptions of product homogeneity, large numbers of buyers and sellers and free entry and exit into the market imply that the activities of the entrepreneur such as decisions on prices, the search for information, the organisation of decision making, the choice of method of production and appeal to buyers and the psychology of decision making can be taken as given.
Under these conditions there exists a state of economic equilibrium within the economy. An equilibrium simply means that given the exogenous factors no actor has an incentive to change behaviour. By definition allocation will be efficient and will correspond to prices that reflect marginal costs (the change in total cost that arises when the quantity produced changes by one unit) and are equal to average costs (the total cost divided by the number of goods produced) (O'sullivan et al. 2006). Under these conditions the average costs of all producers are at their minimum, and there are no profits beyond the minimum rewards required to enable the economic actor to continue operations. This situation is referred to as a single-exit or straight-jacketed situation since “the uniquely best course of action is narrowly delimited from consideration of the objective situational constraints” (Latsis 1972: 51). The decision taken under these circumstances can be termed ‘rational’ since the decision is dictated by the circumstances rather than any internal characteristics of the decision maker that might affect their behaviour. The term rational assumes that the decision makers have specific
expectation that are objectively correct (Manski 2004). Simon refers to this form of rationality as substantives rationality because of the assumption that actors maximize their subjective expected utility on the basis of full information (Simon 1986). Thus in NCE, “economic behaviour depends on and should be explained in terms of the structure of the economic environment and not the decision maker’s internal characteristics”(Latsis 1976a: 51 emphasis in original ) . This means that the psychology, habits, customary practices etc. are outside the scope of analysis in NCE; taking such considerations into account would make the actors choice of action unpredictable.26 Latsis summarizes the underlying principles of NCE in the following way:
a. The approach is individualistic: phenomenon of the market is explained in terms of individual human agents acting in a social situation.
b. The rational choices of the individual agents are so constrained by their situation that only minimal psychological assumptions are required to explain their actions. c. Behaviour is animated by the principle that rational agents act appropriately to the ‘logic of the situation’ (Latsis 1972: 209).
26 The internal characteristics of the actors are central in OIE and will form part of the actor’s motivation or
