The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Sunday, August 15, 2010

Why we urgently need critical thinking on the NBN

The $43 billion National Broadband Network (NBN) is one of the biggest individual financial investments Australian taxpayers will ever make. When it was originally announced, taxpayers were only going to stump up with $4.7 billion of the total price tag. Following a study by McKinsey and KPMG that number skyrocketed to $26 billion because they found that during the early years private investors would not accept the NBN’s risk profile.

If one works on the basis that the NBN will end up being wholly funded by taxpayers, which is likely given that its expected returns are (a) so low and (b) uncertain (read risky), it will increase Australia’s national debt by roughly 30 per cent (assuming it stays on budget, which commentators believe is unlikely), and will cost every household in the country more than $5,000 before they even start paying for the NBN service. The interest repayments on that debt alone would be $2.4 billion per annum assuming that long-term interest rates do not rise.

On a per capita basis, the total cost of the NBN is between six and eighty times more expensive than what Singapore, South Korea and New Zealand are spending on their own lauded NBN solutions. And Australia has similar or higher levels of urbanisation. As the award-winning technology journalist Grahame Lynch recently concluded, the NBN “is the most expensive government intervention of its kind in the world.”

Despite all of this, the NBN has been subject to very little public scrutiny. There has been no detailed cost-benefit analysis published by Treasury on why the NBN is the best possible use of up to $43 billion of taxpayer’s cash. There has been no independent Productivity Commission Inquiry determining the amount of money that the nation should use to subsidise high-speed broadband, and whether, in fact, comparable technology, such as WiMax or ADSL2+, could be supplied at no additional cost to taxpayers via the private sector. The unfortunate truth is that the NBN was a policy developed on-the-fly following a fight with Telstra in the middle of the GFC when government spending was back in vogue.

It is also concerning that the central 100 megabits per second ‘speed’ claim that is being used to sell the NBN does not currently apply to around 70 per cent of all Australian internet traffic. This is traffic that either goes to overseas websites or hits Australian websites hosted offshore where the connectivity speed is determined not by an NBN’s capabilities, but by the submarine cables that link Australia with the rest of the world, and then by the bandwidth that ISPs wish to make available. Current limitations would restrict this traffic to around 2Mbps with or without the NBN.

There is probably a good reason why proper cost-benefit analysis has not been undertaken on the NBN: the benefits are so uncertain and difficult to quantify, and the opportunity costs of spending this money so great, that once you discount the potential returns you would find that its awfully hard to justify spending $43 billion. This is precisely why the government’s own advisors slashed the expected private sector contribution by more than half from the initial estimate of $38.3 billion to just $17 billion employing what are rubbery assumptions that seem unlikely to pass muster with conservative third-parties.

To get a feel for the economic risks, ponder a few of the flaws identified by technology expert Grahame Lynch in the NBN financial modeling carried out by KPMG and McKinsey (note, this was not cost-benefit analysis).

First, Lynch points out that the NBN’s assumed average revenue per user is significantly in excess of what Telstra currently generates.

The next problem he finds is that the NBN modeling supposes that it can increase the price it charges for its services every year when empirical experience suggests these costs do not rise over time.

The most fundamental frailty Lynch and others have drawn attention to is the exceptionally high number of ‘activations’ the NBN’s business is purported to be able make, which imply total consumer take-up of 75-90 per cent of all homes passed by 2035 while at the same time making “the startling observation that NBN take-up is expected to be lower in the wireless areas because of competition from DSL and 3G!” It is sobering to note here that new wireless and copper technologies, such as WiMax and ADSL2+, offer very high connectivity speeds of up to 40Mbps and 24Mbps, respectively.

Lynch concludes that the supporting arguments for the NBN’s business model “are dubious to say the least”, and offers as an example the further claim that it “will gain take-up advantages over comparable projects overseas because of the “pride” Australians will feel in it.”

Possibly the biggest disruptive threat to the NBN’s business is wireless. Around 30 per cent of all internet connections are now wireless and growing at a double-digit rate. Consumers are increasingly shifting towards mobile devices, such as iPads, Blackberries, and laptops. And this trend will only strengthen through time as smart-phone penetration increases and wireless speeds improve. Yet the NBN’s business plan would have us believe that wireless broadband growth will slow, not accelerate.

Interestingly, both those on the centre and left of the political divide, who think that government should be leveraging up its balance-sheet and investing in much more infrastructure, which is a view I subscribe to, and those on the centre-right who question whether the NBN is, in fact, a ‘public good’ that deserves any government funding at all, should have questions about this project.

For the centrists, many opportunity costs loom large. The best-case $43 billion price tag for the NBN could be invested in a range of much more tangible and certain projects that yield arguably higher benefits. For example, this capital could help address the public transport crisis by funding 230km of new metro railway lines—equivalent to 16.5 times the size of the Parramatta to Epping rail link—based on the latter’s costing. It could go a long way to resolving the hospitals crisis by delivering 14,600 new beds (or 43 major hospitals) based on the price of the latest Royal Childrens Hospital in Melbourne. Or it could eradicate homelessness by building 107,500 new homes worth $400,000 each to take the circa 105,000 people without shelter today off the streets.

More basically, imagine if one took the NBN’s $5,000 plus per household price and asked real-world families how they would like to see their money apportioned across, say, public transport, health, education and broadband. How do you think they might respond? My guess is that most would instinctively allocate a small share to internet connectivity, perhaps close to the $520 or less that NZ and Singapore are spending on their own NBN solutions.

Those on the right side of the political spectrum will surely conclude that broadband is not, in fact, a ‘public good’ that the private sector is incapable of cost-effectively providing. The truth is it does and will continue to do so. Many private companies are more than happy to prudently invest their own money in fibre, ADSL2+, and WiMax at no cost to taxpayers. Indeed, the government’s NBN implementation study implicitly recognises this by arguing that the NBN Company should consider leveraging off existing private sector infrastructure—such as hybrid fibre-coaxial networks—in order to deliver its mandate.

There has been a notable paucity of critical thought on Australia’s extraordinarily large NBN commitment. Perhaps this is because media companies believe that they will be big beneficiaries. Yet in an increasingly mobile and wireless world, will cost conscious households really want to spend extra dollars on fixed-line, fibre solutions just so that they can more quickly download content from YouTube or iTunes?

Think of all the businesses that supply you with goods and services every day and consider what proportion might take-up video-conference technology, which is another one of the NBN’s claimed efficiency gains? The local shops, mall or supermarket? No. What about labour-intensive manufacturers, miners or farmers? Unlikely. Kids will still attend schools, and employees will still go to work. For that small minority that do want to telecommute, such as one of my staff members who is based in Adelaide, or perhaps some service business, they can use an existing technology for free. It’s called Skype. My wife and I use it all the time when communicating with our IVF doctors in the US. The best news is it costs taxpayers nothing.

Of course, this choice does not need to be binary; all or nothing. We can support the private sector in the development of better broadband technology. We just don’t need to make a very risky $43 billion punt on one specific solution.

[FWIW, the views above are my own personal opinions.]