Do NBN economics stack up?

The 'wisdom' of subsidising the NBN in rural Australia by effectively taxing urban dwellers is inherently flawed. Here's an alternative.

Is the National Broadband Network sustainable?

I do not mean this in a technical sense. While I am wary of the government using taxpayers' money to ‘pick winners’ in technology, there are many people better placed than I am to crystal ball gaze into the best technology for the internet.

Rather, is the NBN economically sustainable?

The NBN is based on a tried-and-true scheme of hidden cross subsidies. The scheme is quite simple. The government provides a service that is much cheaper to provide in urban areas than in rural Australia. The government bans any private firms from providing this service. Then the government sets a single, uniform price for the service to customers across Australia. The price is high enough to cover all costs, which means that it is much higher than the underlying cost in the cities while it is usually below cost in the bush.

The uniform pricing means that the city-based consumers are effectively being taxed in order to cross-subsidise the bush. If competition were allowed, businesses would enter the city market, undercut the government price and make profits. Prices to city customers would fall. Of course, no private businesses would go into the bush. You can’t make money competing against a government price that is below cost.

Australia Post has used this type of tax-and-subsidise scheme for decades. Australia Post sets a uniform price for delivering a standard letter anywhere in Australia and it is (effectively) illegal to compete against Australia Post to deliver a standard letter. Indeed, this model is so common for postal systems around the world that uniform pricing is sometimes called ‘postage stamp pricing’.

It is important, however, to understand the economics behind the scheme. The NBN version of the scheme has three key features.

First, high-speed internet services will be sold to rural and regional Australia at a price below the cost of providing the services.

This type of subsidised service is not necessarily a bad thing. It is important to make sure that rural and regional Australians have adequate services, including the internet, and the government has a role in providing those services. And sometimes this will mean that the service is sold below cost in rural Australia.

Second, because the loss on rural Australia must be funded, the government is effectively placing a ‘tax’ on high-speed fixed-line broadband delivered through the NBN in urban areas. This ‘tax’ will raise the funds to pay for the rural subsidy. Or as the Australian Financial Review put it:

“[T]he NBN relies on money from dense urban areas like apartment blocks subsiding broadband for unprofitable and sparsely populated rural and regional Australians.”

Of course, it is not called a ‘tax’, but that is what it is. Urban consumers will pay higher prices for fixed-line internet services in order to fund the losses in the bush. This is the only way the NBN can make money.

I have problems with this part of the scheme. It is far from clear that artificially raising the price of internet access in the cities is a good way to raise money to cross-subsidise internet for the bush. Why not push up income or sales taxes instead? Why would we think that it is a good idea to tax new technology rather than other sectors of the economy?

Of course, the NBN cross subsidy keeps the tax hidden and off the government budget. And it has worked for Australia Post for a long time.

Third, because competition in internet services in the city will prevent the government from raising money through its NBN tax, private competitors will be banned from competing against the NBN.

But preventing competition is hard.

The NBN is already facing competition from mobile broadband, but with current technology, mobile broadband is expensive and relatively slow. The NBN also faces competition in central business districts where fibre networks are common. As Business Spectator has noted it is not clear “why small to medium enterprises need the NBN when they have the option to utilise fibre Ethernet readily available from major providers in many areas.”

But the real competitive challenge may come from TPG installing fibre-to-the-basement in major apartment buildings. In September last year, TPG announced that it was planning to connect 500,000 apartments to high-speed internet by bring fibre connections into the ‘basement’ of buildings. TPG’s planned price is significantly less than what Optus is charging for similar services over the NBN.

The communications minister has referred TPG’s plans to Michael Vertigan as part of his cost-benefit inquiry into the NBN. But other telecommunications, companies like Telstra have let it be known that if TPG can go ahead with its plans then they will be right behind.

This is a nightmare for the NBN. As Alan Kohler noted:

“The government must either legislate for the National Broadband Network to be a monopoly or ditch it. There’s other no alternative.”

But that is the problem. The government has legislated to prevent competition. That is why Telstra and Optus have to sell their HFC networks to the NBN -- so they can be incorporated into the NBN or shut down. Either way, they can’t compete against the NBN.

However, it is hard to stop competition from breaking out, especially when there is demand in the cities for fast, cheap internet. Even if the government is able to fend off the TPG threat, it is just the first of many. Indeed, the problem is that the government doesn’t know what competitive threats will face the NBN in the near future. The internet is not snail mail and the NBN is not Australia Post. Innovation will always create ways to undermine a legislated monopoly in a fast moving area of technology. So in the absence of (further) draconian legislation that will stifle innovation, the government can’t effectively legislate for the NBN to be a monopoly.

So what should the government do?

Ditch the ‘National’ Broadband Network and replace it with the “Rural and Regional Broadband Network” (RRBN). Then set a reasonable price for the RRBN. This will be below cost but any loss should be funded using standard taxpayer receipts. Then allow urban internet competition through copper, fibre, mobiles and any other technology. This will ensure that the cities have fast internet at the lowest possible prices. Finally, forget any plans to eventually privatise the RRBN. It will be loss-making. That is the point.

Of course, this will require two characteristics of the government.

First, the wisdom to say that the original NBN plan, with its hidden tax, was always flawed. That should be easy because the plan was developed by the previous government. It is easy to blame them.

Second, the courage to make the cost explicit and put it back in the budget. This is where it should be with transparent taxes funding a transparent loss. But the previous government hid the cost using government accounting conventions for ‘future profitable’ projects. The current government can and should come clean on the cost to fix up the mess they have inherited.

Stephen King does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.

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