Auction theory and policy 1. Why auction theory matters for governments 2. Europe and the 3G auctions: The UK and the Netherlands 3. Auctions and the Victorian Government

1: Why auction theory matters for government Governments: Buy goods (and services) Buy goods (and services) Sell goods Sell goods Auctions overcome information problems (adverse selection) Auctions are transparent

1: Why auction theory matters for government Auction design impacts on behaviour, which in turn impacts on the outcome of the auction Auctions can be tailored to reflect: The government’s objectives The government’s objectives The good/service being auctioned The good/service being auctioned Single units or bundles of units? Do complementarities exist between units? The nature of the market The nature of the market Competitive industry? (Market power a problem?) Collusion likely to be a problem?

2: Europe and the 3G auctions What is a “3G license”? The policy issue: In 2000 six Governments across Europe auctioned off 3G licenses. In 2000 six Governments across Europe auctioned off 3G licenses. 3G new technology: governments had no capacity to estimate the value of licenses. 3G new technology: governments had no capacity to estimate the value of licenses. 3G licenses had a “common value” component 3G licenses had a “common value” component Each country designed its own auction. Each country designed its own auction. Each market had different market conditions (number and size of incumbents and potential market entrants). Each market had different market conditions (number and size of incumbents and potential market entrants). Countries made different numbers/bundles of licenses available for purchase. Countries made different numbers/bundles of licenses available for purchase.

2.1: The UK auctions The UK market conditions: 4 incumbent companies with market advantages 4 incumbent companies with market advantages Several potential market entrants Several potential market entrants Government goals: Assign licenses efficiently Assign licenses efficiently Encourage competition Encourage competition To “realise the full economic value” of licenses To “realise the full economic value” of licenses Limit of one license per bidder (to maintain a competitive industry) The Government hired auction theorists to design the auction and tested the design in experimental labs.

2.1: The UK auctions cont… The original plan was to sell 4 licenses. Because there were 4 incumbents there was concern that an ascending auction (English Auction): Would discourage new entrants, as dominant companies can always out-bid weaker firms Would discourage new entrants, as dominant companies can always out-bid weaker firms May lead to collusion May lead to collusion On the other hand there was concern that a sealed- bid auction may lead to an inefficient outcome, as dominant firms may under-bid in an attempt to capture large surpluses, and therefore be outbid by weaker firms

2.1: The UK auctions cont… The Government therefore planned to run an “Anglo-Dutch” auction: an ascending auction would run until 5 contestants remained, at which point these companies would submit sealed bids at or exceeding the final price. This format performed well in experimental testing.

2.1: The UK auctions cont… At this point, a fifth license became available for sale. As a result the government elected to use a simple ascending (English) auction - the restriction of one license per company and the availability of a fifth license made it possible for a new market entrant to purchase a license. 9 new market entrants participated (+ 4 incumbents) The UK 3G auction raised €39billion This auction format gave the government a good understanding of the value the market placed on 3G licenses.

What can be learned from the UK 3G auction? There is no such thing as a “good auction,” just a “good auction for the particular task.” UK Government hired auction theorists and tested their auction design in the lab to make sure that their design was robust and achieved their goals. 2.1: The UK auctions cont…

2.2: The Netherlands auctions The Dutch market conditions: 5 incumbent companies with market advantages (versus 4 in the UK) 5 licenses for purchase (as per the UK) The Dutch Government used the same design as the UK Government – an ascending auction.

2.2: The Netherlands auctions cont... Recognising that the 5 incumbent companies would be able to out-bid them, smaller companies chose to make deals with the incumbents rather than losing at auction. Only 1 non-incumbent participated (+ 5 incumbents) The Netherlands auction raised €3 billion (versus €39 billion in the UK). The auction did not reveal to the Dutch Government the value the market placed on 3G licenses.

2.2: The Netherlands auctions cont... What can be learned from the Netherlands’ 3G auction? The auction format that works in one set of circumstances is extremely unlikely to work successfully in other circumstances – subtle variations in the market conditions can give rise to big differences between outcomes. Treating auction designs like “blueprints” is extremely risky for governments. Auctions needs to be tailor-made; auction theory and experimental testing will substantially improve auction outcomes.

3: Auctions and the Victorian Government BushTender: The Government wanted to improve native vegetation on private land – therefore needed to procure improvements in native vegetation. The Government wanted to engage private landholders in contracts to improve their native vegetation. A specific goal was that contracts should be “cost-effective.”

3: Auctions and the Victorian Government Problems: 1. It was difficult to measure “improvements in native vegetation” – the good the government wanted to purchase was poorly defined 2. It was difficult to identify the landholders who offered the government good “value for money” (adverse selection) Solution: 1. The Government developed a metric that made it possible to measure the quality and quantity of vegetation improvements that they were purchasing (Habitat Hectare) 2. The Government decided to use an auction mechanism to allocate contracts for improvements in native vegetation.

3: Auctions and the Victorian Government Design questions: 1. First price or second price? (Discriminating price or uniform price auction)? 2. Sealed bid or open auction? 3. Single round or multiple rounds? 4. How encourage participation?

3: Auctions and the Victorian Government The piloted BushTender format: First-price auction (discriminating price auction) First-price auction (discriminating price auction) Sealed bid Sealed bid Single round Single round Encouraged participation through lengthy engagement with potential participants and information distribution. Encouraged participation through lengthy engagement with potential participants and information distribution.

3: Auctions and the Victorian Government

Rare and good value Common and poor value

Auction theory and policy Summary: Auctions are a transparent allocation mechanism Auctions are a transparent allocation mechanism The design of an auction impacts on participants’ behaviour (bidding), and in turn the outcome of the auction The design of an auction impacts on participants’ behaviour (bidding), and in turn the outcome of the auction Well-designed auctions can be used to: Well-designed auctions can be used to: Improve allocative efficiencyImprove allocative efficiency Increase revenue / reduce expenditureIncrease revenue / reduce expenditure Gather informationGather information Auctions must be carefully designed to reflect policy objectives and the specific nature of the good/s being auctioned and market conditions Auctions must be carefully designed to reflect policy objectives and the specific nature of the good/s being auctioned and market conditions Auction theory and can be used to improve auction design, while testing in experimental labs can be used to test the robustness of an auction and to minimise the risk of unexpected outcomes Auction theory and can be used to improve auction design, while testing in experimental labs can be used to test the robustness of an auction and to minimise the risk of unexpected outcomes