New research: returns to broadband investment

Should governments subsidize or build broadband networks? This question is being posed throughout the US; Brian Lambert summarizes the Minnesota landscape in “How the Legislature is cheating Greater Minnesota on broadband.”

Economists aver that to answer this question, we need to know whether the rate of return to private businesses investing in broadband networks is less than or equal to the social rate of return.  The former includes only those benefits that accrue to the company and its investors while the latter includes benefits society gains from the investment but which don’t show up in the company’s profits.

If the private rate of return is equal to the social rate of return, we can trust the market to do a good job of allocating resources towards broadband and there is no need to subsidize private producers or build public networks.  However, if the private rate of return is below the social rate of return then it makes sense for governments to subsidize the investment or invest public funds networks.

A new paper, “Usage-Based Pricing and Demand for Residential Broadband,” sheds light on this question.  Aviv Nevo, John L. Turner, and Jonathan W. Williams use data from ISP providers to examine how consumers react to various pricing packages and “find that FTTP [i.e. broadband] generates significant consumer surplus but that there is a large gap between the private and social incentives for investment in such networks. This suggests that without subsidization these investments will come much later than is socially optimal (p. 24).” Translation: consumers gain a lot of benefits from having access to broadband.  However, private businesses will not build enough broadband capacity to satisfy demand because their private rate of return is too low.  Without government subsidies, they will underinvest in broadband networks.

Thus, we have clear evidence that there is social benefit to be gained by investing in broadband now but by leaving matters to the market we are missing the opportunity to reap these gains.