The Economic Impact of Excluding Huawei from US Wireless Market

1. The Impact on the U.S. Economy of Excluding Huawei from Participation in the U.S. Market for Wireless Network Equipment Debra J. Aron, Ph.D. Vice President, Charles River Associates Phone Number: 312-577-4196 Email: daron@crai.com Presentation at the FY 19 NDAA Section 889 Public Meeting July 19, 2019

2. Introduction • I am an economist (Ph.D., University of Chicago) with 25 years of experience studying and teaching about antitrust, economics, and competition in the telecommunications industry. • I will address the following question posed by DoD, GSA, and NASA: • “To what extent will compliance with the prohibition in paragraph (a)(1)(B) of section 889 incur additional cost or other burden in providing goods or services to the Federal government? Please be specific in describing the impact.” I have been retained and compensated by Huawei to conduct the research reported here. This presentation represents my own independent analysis and opinions.

3. Purpose of This Presentation • I will report on the results of my analysis of the anticipated effects on the U.S. economy of excluding Huawei from the U.S. market for radio access network (“RAN”) equipment: • The effect on the U.S. economy of delaying 5G deployment • The effect on the prices of RAN equipment in the U.S.

4. Overview of Results • I estimate that the impact of excluding Huawei from the U.S. market for RAN equipment will range from $104 billion to $241 billion in reduced GDP over a six-year period. These anticipated losses will result from delays in 5G deployment and adoption, which in turn affect GDP. • I also find that excluding Huawei from the U.S. market has caused RAN equipment prices in the U.S. to be 12-14 percent higher than they would be if Huawei were allowed to compete in the U.S. market. 

5. Impact of Huawei’s Exclusion from the U.S. Market on the Federal Government • Because of the economy-wide impact on carriers’ costs, the prices of services and equipment provided to the Federal Government will be affected by the absence of Huawei.  • For example, the Federal Government expenditures include funds for: • Broadband infrastructure in rural areas and areas lacking broadband infrastructure • Broadband infrastructure for educational and healthcare purposes • The Federal Government would be expected to incur additional costs from assisting rural carriers in replacing Huawei’s equipment. • The availability, diversity, innovativeness, and quality of services and equipment provided to the Federal Government will also be affected by the absence of Huawei.

6. Other Researchers Have Estimated the Cost to Replace Existing Huawei Network Equipment in U.S. Networks • It will be costly for carriers (largely, rural carriers) to “rip and replace” Huawei equipment that is already in place in their networks. • Other researchers estimate that to “rip and replace” existing Huawei equipment will cost rural carriers approximately $1 billion and take 3-7 years.1 • My analysis estimates the costs to the economy over and above these strict replacement costs. 1 Jeff Johnston, “Equipment Ban Creates Static for Rural Telecom Operators,” CoBank, June 2019.

7. 5G Technology Will Enable Transformative Benefits and Uses • 5G will provide massive capacity, speed, and latency improvements.5G networks will: • Support 100 times more traffic than 4G • Increase peak speeds from 4G by a factor of 20 • Decrease latency from 4G by a factor of 10 • 5G is anticipated to enable innovation in industries across the economy, including self-driving cars, logistics, the Internet of Things, smart grid electric systems, public safety, health and wellness, and smart cities.

8. Context of 5G Deployment Challenges in the U.S.: The “Spectrum Gap” Problem • The U.S. has not released mid-band spectrum for 5G, which is a key spectrum band for 5G deployments that is used in the rest of the world. • AT&T, T-Mobile, and Verizon have deployed 5G using high-band spectrum (frequencies above 24 GHz, also known as “millimeter waves”). • Millimeter-wave spectrum has limited coverage and penetrates poorly through walls and other obstacles. • It requires a high density of cell sites to provide continuous coverage of an area. • It is uneconomic to deploy 5G using millimeter-wave spectrum except in dense urban areas and indoor locations.

9. Context of 5G Deployment Challenges in the U.S.: The “Spectrum Gap” Problem • T-Mobile plans to deploy 5G in low-band spectrum (600 MHz). • Low-band spectrum does not offer the same high speeds as high- or mid-band spectrum because (a) available spectrum bandwidthsare narrow, and (b) the infeasibility of Massive MIMO technology in low bands due to large antenna size. • Sprint is the only carrier that has mid-band spectrum (2.5 GHz) due to legacy arrangements; it is using this spectrum for its 5G deployment.

10. Historical Context: Unique Technology Needs Disadvantage the U.S. in 5G Deployment and Adoption • History has shown that U.S. deployment and penetration of new wireless technology is delayed when the U.S. deviates from the globally-adopted technology ecosystem (in this case from the deployment of 5G using mid-band spectrum). • The U.S. lagged well behind Europe in 2G and Japan in 3G. • The U.S. is already behind South Korea in 5G deployment and adoption. South Korea reportedly has over 1 million subscribers and substantially more extensive deployment than the U.S. • The U.S. recognizes that mid-band spectrum is critical for 5G deployment and intends to release it to carriers in 2019-2020,1 but no date has been set. 1Statement of Chairman Ajit Pai, Federal Communications Commission, Hearing on “Oversight of the Federal Communications Commission,” Before the United States Senate Committee on Commerce, Science, and Transportation, June 12, 2019, available at https://docs.fcc.gov/public/attachments/DOC-357959A1.pdf.

11. Many Countries That Use Huawei’s Network Equipment Have Better-Performing 4G Networks Than the U.S. • The U.S. currently ranks 30th in the world by the speed of its 4G wireless network. Countries that rank higher include: • South Korea (#1) ­­­­­ – Switzerland (#7) • Norway (#2) – Denmark (#8) • Canada (#3) – Belgium (#9) • Australia (#6) – Hungary (#11) • These countries used Huawei’s network equipment (among others’) for their 4G deployments. • Carriers in several European countries have already deployed or will deploy Huawei’s 5G equipment in their networks (e.g., Finland, Switzerland, and the United Kingdom).1 1 Rita Liao, “Huawei says two-thirds of 5G networks outside China now use its gear,” TechCrunch, June 25, 2019, at https://techcrunch.com/2019/06/25/huawei-wins-5g-contracts/.

12. Excluding Huawei Will Delay 5G in the U.S. Over and Above the Delay Already Caused by the Spectrum Gap • Only 5 companies in the world have significant expertise, investment, and capabilities in the development and production of advanced wireless RAN equipment: • Huawei • Ericsson • Nokia • ZTE • Samsung • Huawei is a top 3 Information and Communications Technology (“ICT”) producer by R&D investment in the world and a top 5 of all companies by R&D investment in the world.

13. Huawei Is a Leader in 5G-Related Patents

14. Huawei Engineers Are the Most Active in 5G Industry Technical Meetings

15. Huawei Is a Leader in 5G Contributions

16. Huawei Currently Has the Highest Global Revenue Share in the Market for RAN Equipment (Despite Virtually No Sales in the U.S.)

17. Independent Analyst Reports Find Huawei to Be the Leader in 5G RAN • GlobalData, a market research firm headquartered the U.K., compared 5G RAN macro base stations offered by Huawei, Ericsson, Nokia, Samsung, and ZTE in terms of baseband unit capacity, breadth of radio unit portfolio, installation ease, and technology evolution, based on the information provided by each vendor.1 • Huawei was found to be the leader in each of these categories and overall. 1 Ed Gubbins, “5G RAN: Competitive Landscape Assessment,” GlobalData, June 7, 2019.

18. Massive MIMO Is a Key 5G Technology • Massive MIMO is a multiple input multiple output active antenna. It is a key technology in 5G. • Massive MIMO increases network capacity and spectral efficiency, and provides better coverage. • Smaller antennae sizes are used in 5G, because 5G uses higher frequency spectrum, which enabled widespread use of Massive MIMO technology in mid-band and millimeter-wave spectrum. • Sales of Massive MIMO have accounted for around 82 percent of total 5G RAN equipment sales so far. Source: “Massive MIMO,” Sprint, at https://business.sprint.com/5g/massive-mimo/

19. Huawei’s Massive MIMO Equipment Is Far More Widely Used GloballyThan That of Any Other Vendor • The evidence already discussed suggests that Huawei’s Massive MIMO equipment is more advanced than that available from any other vendor. • Huawei has a 67 percent revenue share in LTE Massive MIMO.1 • Huawei has a 32 percent revenue share in 5G Massive MIMO1 despite being absent from the U.S. market, which is one of the two main early 5G adopters in its available spectrum bands. 1 Data are provided by Dell’Oro Group, Inc.

20. Delays in 5G Deployment Will Harm the U.S. Economy • The evidence shows that higher penetration rates of new generations of wireless technology increase GDP.1 • Deployment of a new generation of a technology directly contributes to GDP via mobile carriers’ expenditures and job creation. • New technology innovation indirectly contributes to GDP by enabling innovation in other sectors of economy, such as: • Internet of Things • Virtual and augmented reality • Self-driving cars • 8K (ultra high-definition) video • 1 Harald Gruber and Pantelis Koutroumpis, “Mobile telecommunications and the impact on economic development,” Economic Policy (July 2011), pp. 400-402, Table 2; “What is the impact of mobile telephony on economic growth? A Report for the GSM Association.” Deloitte, November 2012, pp. 2, 11, 13-14.

21. The Absence of Huawei from the U.S. Market Will Delay Deployment and/or Penetration of 5G in the U.S. • The evidence provided is that Huawei’s 5G RAN equipment is the most advanced in the world; its absence will affect quality of service and dampen 5G penetration; • Huawei’s RAN equipment, especially Massive MIMO, is one of the most widely used in the world, implying a more developed ecosystem around it, facilitating deployment and adoption; • Carriers are simultaneously deploying networks worldwide, inevitably putting pressure on supply in a market with few viable suppliers; vendors have experienced equipment delays in other countries; • Huawei’s competitive presence would drive down prices, encouraging faster deployment; • A study by U.K.-based analyst firm Assembly found exclusion of Huawei from the U.K. would delay deployment there by 18-24 months.1 1 “The Impact on the UK of a Restriction on Huawei in the Telecoms Supply Chain,” Assembly, April 5, 2019, p. 3.

22. Delays in 5G Deployment Will Lead to Delays in 5G Adoption in the U.S.

23. Estimated Economic Impact on U.S. GDP of Delaying 5G Adoption by 6, 12, and 18 Months in the U.S. Due to Absence of Huawei, Over and Above Delay from Spectrum Gap1 1 These results are based on econometric analysis of the effect of penetration rate on GDP per capita in 7 countries over 5 years. See Appendix 1 for details.

24. Effect of Excluding Huawei from the U.S. Market on Prices of RAN Equipment in the U.S. • Banning Huawei significantly increases the concentration of the market for all wireless RAN equipment. • The U.S. RAN market is served almost entirely (89.2%) by only two vendors, Nokia and Ericsson.1 • (both of whom, incidentally, also have joint ventures for manufacturing with companies that are partially owned or controlled by the Chinese government.2) 1 “M18A_Mobile_RAN_Total_Regions_Vendor_Table_1Q19 no 5G.xlsx,” tab “Regions Total,” Dell’Oro Group, Inc. 2 Nokia Corporation, Annual Report on Form 20-F, p. 190; “Ericsson awarded GSM/GPRS expansion contract in China,“ Ericsson Press Release, May 28, 2004, at https://www.ericsson.com/en/press-releases/2004/5/ericsson-awarded-gsmgprs-expansion-contract-in-china; “Investor Relations: Ownership,” Panda Electronics Group, Co., Ltd., at http://www.panda.cn/gqjg/index_393.aspx; “Nanjing Ericsson Panda Communication Co Ltd,” Bloomberg L.P., at https://www.bloomberg.com/profile/company/0180724D:CH; Telefonaktiebolaget LM Ericsson, 2018 Annual Report, pp. 107-108; Nokia Corporation, Form 20-F for the fiscal year ended December 31, 2017, p. 188.

25. Effect of Excluding Huawei from the U.S. Market on Prices of RAN Equipment in the U.S. • Specifically, the Herfindahl-Hirschman Index (a standard economic measure of market concentration) of the market for RAN equipment increases from around 3,000, which is already a highly concentrated market, to over 4,000 — an increase of around 1,000 points — in the absence of Huawei.1 • Economists find that such an increase in market concentration is likely to cause prices to increase significantly.2 1 See Appendix 2 for details. 2 “Horizontal Merger Guidelines,” U.S. Department of Justice and the Federal Trade Commission, August 19, 2010, Sec. 5.3.

26. Effect of Excluding Huawei from the U.S. Market on Prices of RAN Equipment in the U.S. • Using standard tools of merger analysis, I estimate that the absence of Huawei from the U.S. market increases prices of RAN equipment by 12-14 percent.1 • Such a price increase is considered to be significant and damaging to social welfare. 1 This result is based on a Gross Upward Pricing Pressure Index (“GUPPI”) analysis. See Appendix 2 for details.

27. Thank you!

28. APPENDIX 1

29. Notes for Exhibit on Slide 23: • [1] Mid-band spectrum is assumed to be allocated in Q3 2019 according to the FCC estimate, and material adoption of 5G is assumed to start in Q4 2019. • [2] I assume that without a delay in 5G deployment due to Huawei ban, 5G penetration rate between Q4 2019 and Q4 2024 would replicate 4G penetration rate between Q1 2009 and Q1 2014. I assume that if 5G deployment is delayed, 5G penetration rate would follow the same trajectory as in the scenario without delay, but its start would be delayed by the time equal to the duration of delay. For example, when 5G deployment is delayed by six months, the 5G penetration rate is assumed to be zero in Q4 2019 and Q1 2020 and for Q2 2020-Q4 2024 it is assumed that the 5G penetration rate in Qt equals the 5G penetration rate from the scenario without delay in Qt+2, where t = Q4 2020,...,Q2 2024. The annual penetration rate is calculated as the average of quarterly penetration rates. • [3] I assume that a 1 percentage point decline in 5G penetration rate would result in a 0.035 percent decline in GDP per capita. This assumption is based on the regression estimates. • [4] Real GDP per capita is assumed to grow at the rate of 1.6 percent per year. This estimate is calculated as the compounded growth rate of real GDP per capita between 2012 and 2018, i.e., GDP per capita growth rate = (GDP per capita2018/GDP per capita2012)^(1/6)-1. • [5] U.S. population is assumed to grow at the rate of 0.69 percent per year. This estimate is calculated as the compounded growth rate of U.S. population between 2012 and 2018, i.e., U.S. population growth rate = (U.S. population2018/U.S. population2012)^(1/6)-1. • [6] The discounted present value of total decline in real GDP is calculated according to the following formula Σt = 2019,...2024 Real GDPt/(1+0.035)(t-2019), where 3.5 percent is the social discount rate from Mark A. Moore and Aidan R. Vining. "The Social Rate of Time Preference and the Social Discount Rate." Mercatus Research Paper, December (2018), at https://www.mercatus.org/system/files/moore_and_vining_-_mercatus_research_-_a_social_rate_of_time_preference_approach_to_social_discount_rate_-_v1.pdf, p. 3.

30. Sources for Exhibit on Slide 23: [1] "Real gross domestic product per capita, Chained 2012 Dollars, Annual, Seasonally Adjusted Annual Rate," Federal Reserve Bank of St. Louis, accessed June 6, 2019, at https://fred.stlouisfed.org/series/A939RX0Q048SBEA. [2] "Gross domestic product per capita, Dollars, Annual, Not Seasonally Adjusted," Federal Reserve Bank of St. Louis, accessed June 6, 2019, at https://fred.stlouisfed.org/series/A939RX0Q048SBEA#0. [3] "Population, Thousands, Annual, Not Seasonally Adjusted," Federal Reserve Bank of St. Louis, accessed June 6, 2019, at https://fred.stlouisfed.org/series/POPTHM#0. [4] GSMA Intelligence, "Country Dashboard," 2019, for the United States. [5] “DataBank. World Development Indicators,” The World Bank, Series "GDP per capita (constant 2010 US$)," "Trade (% of GDP)," "Net investment in nonfinancial assets (% of GDP)," "Labor force, total," at https://databank.worldbank.org/data/source/world-development-indicators. [6] Mark A. Moore and Aidan R. Vining. "The Social Rate of Time Preference and the Social Discount Rate." Mercatus Research Paper, December (2018), at https://www.mercatus.org/system/files/moore_and_vining_-_mercatus_research_-_a_social_rate_of_time_preference_approach_to_social_discount_rate_-_v1.pdf, p. 3. [7] Statement of Chairman Ajit Pai, Federal Communications Commission, Hearing on “Oversight of the Federal Communications Commission,” Before the United States Senate Committee on Commerce, Science, and Transportation, June 12, 2019, available at https://docs.fcc.gov/public/attachments/DOC-357959A1.pdf.

31. APPENDIX 2

32. Estimated Price Increases of RAN Equipment Resulting from Huawei’s Absence From the U.S. Market See additional notes and sources on the next two slides.

33. Notes for Exhibit on Slide 32: [1] I assume that gross margins for Huawei’s and Samsung’s network equipment, which are not reported separately from their handset and other business lines, are equal to Ericsson's gross margin, which is a conservative assumption. [2] Each vendor’s percentage price increase in the absence of Huawei from the U.S. market equals [2*DiH*MH*pH/pi+DHi*(DiH+DHi)*Mi]/[4-(DiH+DHi)2], where DHiis the diversion ratio from Huawei to vendor i, and DiHis the diversion ratio from vendor i to Huawei, MH is Huawei's gross margin, Mi is vendor i's gross margin, and pH/pi is the ratio of Huawei's price to vendor i's price when Huawei is present in the market; i indexes Ericsson, Nokia, Samsung, ZTE, and Other. [3] A diversion ratio from Huawei to vendor i is estimated as rsH/(1-rsi); a diversion ratio from vendor i to Huawei is estimated as follows: rsi/(1-rsH), where rsi is the revenue share of vendor i in North America in 2018, rsH is the revenue share of Huawei in North America in 2018, and i indexes Ericsson, Nokia, Samsung, ZTE, and Other. [4] The ratio of Huawei's price to vendor i's price is calculated as the average of the price ratios of Huawei's LTE-FDD products to vendor i's LTE-FDD products in Q1 2019. The products used in this calculation include Macro eNodeB, Micro eNodeB, and Pico eNodeB for LTE-FDD; and i indexes Ericsson, Nokia, Samsung, ZTE, and Other. [5] The Herfindahl-Hirschman Index (“HHI”) in the presence of Huawei in the U.S. market for RAN equipment is calculated as follows: HHIH = (RSHuawei)2 + (RSEricsson)2 + (RSNokia)2 + (RSSamsung)2 + (RSZTE)2 + (RSOther)2,where RSidenotes the revenue share of vendor iin the presence of Huawei in the U.S. market; and the HHI in the absence of Huawei from the market is calculated as follows: HHIWH = (rsEricsson)2 + (rsNokia)2 + (rsSamsung)2 + (rsZTE)2 + (rsOther)2, where rsi denotes the revenue share of vendor i in the absence of Huawei from the U.S. market.

34. Sources for Exhibit on Slide 32: • [1] "M18A_Mobile_RAN_Total_Regions_Vendor_Table_1Q19.xlsx," tab "Regions Total," Dell'Oro Group, Inc. • [2] "M23A_LTE_FDD_Vendor_Table_1Q19.xlsx," Dell'OroGroup, Inc. • [3] "Huawei Investment Holding Co Ltd Financials.xlsx," S&P Capital IQ. • [4] "Nokia Corporation (HLSE:NOKIA) Financials in USD - Excel Workbook.xlsx," S&P Capital IQ. • [5] "Telefonaktiebolaget LM Ericsson Financials in USD - Excel Workbook.xlsx," S&P Capital IQ. • [6] "Samsung Electronics Co Ltd KOSE A005930 Financials in USD - Excel Workbook.xlsx," S&P Capital IQ. • [7] "ZTE Corporation (SZSE:000063) Financials in USD - Excel Workbook.xlsx," S&P Capital IQ. • [8] Carl Shapiro “Unilateral Effects Calculations,” last updated: October 2010, at http://faculty.haas.berkeley.edu/shapiro/unilateral.pdf, pp. 2-5.