Nobel Laureate Richard Thaler's Views On Auctions

The article by Shyam Ponappa was published in Business Standard on November 1, 2017 and in Organizing India Blogspot on November 2, 2017

You may be surprised to learn that the central government has been applying ideas from this year’s Nobel Prize winner for economics, Richard Thaler, even before the award. According to press reports, a “Nudge” unit was set up last year (2016) by the Niti Aayog in association with the Bill & Melinda Gates Foundation. Its purpose is to apply behavioural insights in policymaking for initiatives such as Swachh Bharat, Jan-Dhan Yojana, and Digital India. There are issues about ethics and motivation in the use of “nudges”, of course, with the best nudges likened to effective GPS devices that make it easier for people to get where they want to go with enabling information, and without covert manipulation.

Recognise, however, that manipulation can cut both ways. It can be beneficial for those being influenced, as when we eat healthier, observe regulations, or manage waste better. It can also be detrimental, as when manipulators entice, persuade, or coerce us to act against our interests, whether it is the private sector, government or vote seekers. Examples are enticements or misleading consumer information, government pressure for compliance without appropriate regulatory bases, or populist measures for votes.

Incidentally, Mr Thaler also advises the $6-billion Undiscovered Managers Behavioral Value Fund, which reportedly does better than 97 per cent of its peers, with average annual returns of 16 percent.

Ironically, one of Mr Thaler’s powerful early insights has been ignored and is awaiting discovery and application especially in India. It is about the “winner’s curse” in auctions, the phenomenon that winners of highly contested auctions tend to overbid. This is because when there is strong contention for a desirable asset, the one who most overvalues the asset tends to bid the highest. Mr Thaler demonstrates that the curse occurs in two ways: Where the winning bid exceeds the value of the winnings, or where the gains are below expectations. Mr Thaler’s 1988 paper demonstrated these effects through examples including oil and gas leases, corporate takeovers, publishing rights for books, and bidding for baseball players.1 This is especially important for India because we need more effective resource management, whether of coal/fuel for power, or of spectrum for communications. We can ill-afford the high opportunity costs of bad policies. 

To be fair to policymakers in India, findings by Mr Thaler and others on auctions have been ignored by other governments greedy for immediate revenue. The UK, Europe and the USA went through disastrous 3G auctions that bankrupted their telecommunications industries. The exceptions were the Scandinavian countries and others such as Japan, South Korea, and China, where circumstances were managed so that there were either no auctions, or less contentious auctions.  Tomes have been written on the “success” of high bids that resulted in enormous government collections. The consequences for the operating companies, however, were devastating, because of the severe drain on their finances from the heavy up-front investments. This was aggravated by the collapse of the technology bubble in 2000.

All the following auctions had disastrous outcomes for services:2

1994: The first US auction netted huge bids. Soon after, a number of “successful” bidders declared bankruptcy.

In India, the 1994 auction was followed by chaos because of overbidding and default. The sector recovered only after the auction fees were set aside for revenue-sharing in 1999 through the New Telecom Policy (NTP 1999), and lower shares were set in 2003.

1995-1996: US “C”-Block auction — several “successful” bidders declared bankruptcy.

2000 UK and 2001 EU 3G auctions: Netted $35 billion in the UK. In Austria, Germany and Italy, bids netted over $100 billion, 10 times the expectation. Considered a huge success, but winners couldn’t repay their debts, and the markets took a decade to recover.

2010: India’s 3G and broadband wireless auction with over Rs 1 lakh crore bid was considered a great success. Having paid too much for spectrum, operators struggled thereafter and new systems are slow to roll-out.

Meanwhile, auction experts wrote disparagingly of “failures” (low fees) in countries such as the Netherlands, Switzerland, Sweden, and ignored countries such as South Korea, Japan and Finland where there were no auctions (until 2009). However, these “failures” had the best broadband services, according to a 2010 study by the Saïd Business School at Oxford.

After India’s 2015 auction, researchers at ICRIER observed that the anticipated growth dividend from telecom didn’t materialise. Their rhetorical question and answer: “Does this mean the much-needed mobile broadband ecosystem will be further pushed into the future? If so, this would be another case of lost opportunity in telecom.”3 And that’s what it has been so far.

Broadband is an essential aspect of infrastructure. For India to break out of its low-growth trajectory, our policies have to recognise the impediments caused by spectrum fragmentation and high-cost auctions, and create practicable alternatives such as shared networks including spectrum that is paid for only when it is used. Also, more open-access and light-licensed bands in line with global developments will help India reap the benefits of ecosystems of devices as they evolve, e.g., in 60 GHz and TV White Space bands (for which India is ideally positioned). Instead, these technologies are blocked as is the spectrum, which remains unused, creating more barriers for ourselves by having to devise high-cost workarounds. Our ministries – for communications, electronics and information technology, information and broadcasting, defence, and finance – need to address technology applications and policies collectively to induct and align our systems and practices with global developments now and for the future.

Shyam (no space) Ponappa at gmail dot com

1. Richard Thaler, “Anomalies: The Winner’s Curse,” Journal of Economic Perspectives 2, no. 1 (Winter 1988): 191-202

2. There was one successful auction in India in 2001 for a fourth mobile operator in each circle (state), when markets were depressed and competition was subdued. Other auctions in India and abroad hailed as successes because of high-auction bids resulted in constrained networks and services