Reforming the `universal services obligation' in Indian telecom

For many decades, telecom policy in India was distorted based on two excuses: the need to utilise this lever of power to "help poor people" and the need to "protect national security". What was really going on was the capture of an area of the Indian economy by the Department of Telecommunications, which was policy maker, regulator and service provider, all rolled into one. If you wanted to start a mobile telephone company, you had to come to DOT for permission, and they would say no. Extravagrant claims were made about systemic stability and the interests of poor people, in order to defend an entrenched status quo.

One of the singular achievements of the late 1990s was the political capital that was deployed at taking on DOT and breaking this monopoly. I don't think anything has happened to national security, and the results were miraculous for poor people. Decontrol, competition and the entry of private + foreign companies has done more for the interests of poor people than decades of socialism did.

That left the `Universal Services Obligation', a tax which has to be paid by all telephone companies in order to support telephony for poor people. I have previously argued that such taxation is unfair: if the government wants to run such a program, it must do so on-budget and not by charging an excise on just one sector. The income tax and the GST are the most efficient taxes; it is distortionary to have any other tax which penalises any one industry.

Earlier, USO was a cost-plus scheme where telephone companies were reimbursed absurdly high "costs" associated with placing a telephone in a village. Today Business Standard has a great edit about the benefits of shifting USO to an auction based and technology-neutral system:

Less than five months after the government amended the law to allow the Universal Service Obligation (USO) Fund to be used for subsidising even mobile phones and broadband services in the rural areas, the results are there for all to see. Mobile phone firms have come up with bids that ask for a subsidy that is a fraction of the benchmark price. In the case of Cluster 1, for instance, a benchmark price of Rs 394,967 had been set as the cost of building a mobile phone tower from which rural mobiles would be serviced; against that, the winning bid from GTL Infrastructure is for Rs 197,484. In the case of Cluster 10, to take another example, the benchmark price was Rs 423,860 while BSNL has won the bid by asking for a subsidy of just Rs 80,222. As for the other part of the subsidy (required for the electronics on the tower), most bidders have said they dont want itthat is, with the cost of the physical towers having been met, they are confident that they have a business model that can provide phones to rural India at costs low enough to bring in sufficient demand. Admittedly, this does not mean that the rural telephony model is robust enough to do away with subsidies altogether, but the heartening point is that the level of subsidy required has come down dramatically. It is reasonable, therefore, to expect a surge in rural telephony, with the attendant gains in connectivity and productivity that can be expected to follow when this happens.

Contrast this with the earlier situation in which the USO Fund was available only for fixed-line phones. This was exorbitantly costlythe Telecom Regulatory Authority of India (Trai) had estimated in 2005 that this model would need nothing less than Rs 30,457 crore by 2010 to set up all of 28 million rural phones, thereby reaching the rural tele-density target of a modest 4 per cent. Those numbers were forbidding, and that is when Trai came up with the model of subsidising the tower, which would service more users at a fraction of the cost. The other negative aspect of the earlier model was that, since fixed lines require physical digging and laying individual lines, progress was slow. Of the Rs 14,000-odd crore that will be collected by month-end through the five-year-old USO levy on phone services, just Rs 4,500 crore is expected to be spent! Since setting up mobile phones is faster, such backlogs can now be tackled.

The lesson this holds with regard to government subsidies in general should be obvious, namely that it is unwise to get married to particular technologies or policy prescriptionsif a new or different technology or method provides the same result, it should be adopted. To extend the logic to the education sector, for instance, if privately-run schools can ensure the same or a high quality of education as compared to government-run schools, channelling subsidies to private schools is clearly a good idea. The other lesson is that it pays to try and work through the market. Instead of fixing a subsidy based on normative cost, potential service providers should be asked to do a reverse-bid on what they require to provide the same servicethis is the only way to bring into play those efficiencies that are normally associated with free markets.