Behold! The NBN Cost-Benefit Analysis

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After slamming the last Government for not doing a cost-benefit analysis on the NBN, Malcolm Turnbull has produced the goods. My view on cost-benefit analysis remains unchanged: if you have already decided what to do, a cost-benefit analysis is of no help except for vindication.

Nonetheless, there is another unintended consequence of doing one: the Minister in charge of it all has to explain it. Well I have to admit that I was impressed by Malcolm Turnbull’s “on the fly” professorial treatment at the Guardian. There aren’t many politicians who can explain optimisation while at the same time using the notion of ‘marginal utility’ correctly but there you have it.

What is nice about the cost-benefit structure is that it grounds the debate and makes assumptions clearer. For instance, Turnbull argues that on the supply-side costs of middle of the road technologies (that support fibre to the node) are falling (or improving in their quality) at a faster rate than technologies that support fibre to the premises. I’m not sure whether that is the case but if it is, then that is support for fibre to the node. Turnbull also does not assume that technology is changing the ‘utility’ function that drives the demand for broadband. However, as many will argue, this assumption would, based on experience, not be valid. What the analysis forces people to do, therefore, is explain precisely how demand conditions are changing rather than ‘this is more and I want more.”

But let’s turn to the report itself. I’ve skimmed it because, frankly, that is all the exercise deserves (given that it won’t impact decision-making and all). The first odd bit is that the benefits and costs are not relative to say not having done anything years ago but relative to what they are intending to do. That means that if that is the best, it will have the highest ‘net benefit relative to the reference case.’ But that doesn’t mean that it has a positive net benefit overall. To be sure, as a matter of economic decision-making, net benefits relative to the status quo is a good approach but in a document like this it triggers some scepticism.

Moving on, the report is useful in that it provides some assumption testing. For instance, the report concludes that at the current level of willingness to pay (WTP) for broadband (I’ll return to how this is measured below) then the current government policy has higher net benefits than the FTTP policy of the previous government. But as Turnbull’s little lecture tells us, if WTP grows then the optimum will shift. The report says that, in a decade’s time, the optimum will shift is WTP is 250% higher than it is today (i.e., it grows at about 13% per annum). Now, let’s think about what that means. It does not mean that people use two and a half times more broadband than they do today. Instead, it means that their WTP for very high speed broadband will be two and a half times more than today. 

To get a sense of that, consider what the equivalent thing would have been from the perspective of 2004. There was no YouTube so the demand for broadband speeds of today would have been driven by YouTube. My guess is that (based on current Telstra broadband prices) that WTP of the marginal consumer increased from close to zero to over $50 per month. Thus, the WTP growth criteria was easily met which is why we have high speed cable running past most urban households. The point is that it is not that hard to imagine a new product coming out that does, in fact, drive WTP growth of the order that changes the optimum network. (Virtual reality comes to mind as a possibility but, the difficulty here is that it is hard to tell). That said, the fact that 6 years ago, a government believed that demand in four years would be high enough to justify FTTP looks somewhat silly.

On to WTP itself. The report uses ‘choice modelling.’ This is a standard way of trying to extract consumer willingness to pay. The issue faced is that when it comes to some products, consumers may not fully understand what they are payiing for. So the methodology includes some random sample who are given a lesson in broadband speeds and capabilities. This allows them to derive a WTP estimate for broadband today. This is a much better approach than the craziness that we have seen in the past on broadband in Australia and, it looks pretty reliable as far as these things go. 

The problem is that (a) it cannot possibly take into account new products and (b) it is based on private values. The first problem is endemic to these exercises. As I pointed out, an analysis in 2004, would have likely got the optimal network spectacularly wrong and what the report does not really grapple with is that it may be wrong in the same way again in 2014. That said, we move beyond our ability to do objective analysis when we get into technological forecasting but it is worth emphasising that this issue doesn’t go away.

The second problem is more critical. We have to remember that this is largely a public investment. The relative comparator is that the investment is all private. That scenario is not really investigated (as far as I can see) and so it is surely the case that we want the public benefits from this government policy to be enumerated and not simply a calculation of private ones. I guess that is too much to expect in this world but it still remains that the NBN is a massive public outlay mostly benefiting the rich. If it could bring real competition that would diffuse the benefits to the wider population but I am yet to see a plan as to how that is going to emerge.

9 Responses to "Behold! The NBN Cost-Benefit Analysis"
  1. Joshua,
    It is good for a change to see you blogging on a topic where you are well informed. You really should do more on telcos and broadband. A lot of resources are being consumed in the sector, and there is an amazing absence of serious and rigorous economic debate.
    During the years of the Labor government, it was difficult for a most academic economists to criticize the stupidity of the original NBN program. Labor is “our team”, and it is disloyal to criticize “our team”. There were a few exceptions, but you know what I mean.
    But thoughtful critiques help everyone.
    Do not become cynical, and do not encourage cynicism in others, because it discourages thoughtful critiques of policy.
    In this blog you say: “But let’s turn to the report itself. I’ve skimmed it because, frankly, that is all the exercise deserves (given that it won’t impact decision-making and all).” Well, that’s a bad sign!
    Buck up, dig in, and be constructive.
    Casey

  2. One benefit of the FTTN model is that it will still allow consumers with higher WTP to make additional investments and get FTTN, and they can make these investments closer to when their WTP justifies it.

    I think we can safely assume that the consumers with the highest WTP are not heterogeneous, they are more likely to live in large cities, and probably within 10km from CBDs. I think this is supported by the rollout out of data delivery networks around the world and also in Australian households’ investment in media and technology.

    As someone who grew up on a farm, I’ve heard the social equity argument here, but given the extremely high unit cost of delivering bandwidth to low-density populations, there are probably other investments which provide greater utility to them (education & mental health come to mind).

    Great piece Joshua, Thanks.

    • Sorry that should be.

      One benefit of the FTTN model is that it will still allow consumers with higher WTP to make additional investments and get FTTP, and they can make these investments closer to when their WTP justifies it.

  3. Josh, interesting piece. A non-rhetorical question: why do you think that “an analysis in 2004 would have likely got the optimal network spectacularly wrong”, and which error(s) would it likely have made?

  4. One of the assumptions they make was that compression algorithms will improve by 9% each year, reducing demand. As a computer engineer, I’m highly skeptical of this. There is only so much entropy that can be removed from a signal, and we’re getting to diminishing returns in video compression.

    Another criticism I have is that while they consider a case where the FTTN has to be replaced by FTTP, they never enumerate that scenario in their costs – just that they assume it will cost 80% of FTTP costs. What is the point of a CBA that goes out of its way to avoid expressing a cost? Especially one that is highly probable. (especially given how much time and effort they put into two improbable cases -‘let’s stop building’ and ‘let the regions rot’.

    Finally all of the ‘advantage’ of FTTN vs FTTP is based on a faster roll out. We’re not seeing a faster roll out here on the ground. Everything seems to have ground to a halt for a year (could just be my electorate).

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