The net effect

15 November 2010 |

Tim Phillips examines the impact of telecoms on the global economy, from boom and bust to brain drains and urbanisation, and looks at the implications of current trends.

The effect of telecoms on the global economy – and the global economy’s effect on telecoms – have been topics for discussion among academics for 100 years. Early journal articles fretted about the potential of public telephones to spread influenza epidemics and the negative health impact of the stress (even though the word was not used at the time) of making and receiving telephone calls.

By 1957, the Journal of Finance was publishing a “Long-Range Outlook for Financing”, contributed by J J Scanlon of the American Telephone and Telegraph Co, who concluded from his research that: “The financial aspects of this period promise to be both challenging and stimulating for everyone concerned.”

The analysis is more rigorous in 2010, but the themes are the same as Scanlon’s. Do we have enough money to spend? Is the economy growing, and where? And how are customers changing? In 1957, Scanlon had already noted that increased mobility and population growth were both drivers of his business – and a problem of how you provision resources. Half a century on, the issues remain.

In his final prediction for the future, Scanlon’s experience of the great depression gave him an insight into the fragility of the 1950s boom that later generations often forgot. “We shall probably see periods of accelerated growth followed by periods of slackening, during which temporary dislocations will be adjusted.” He got that bit right. 

Temporary dislocations: boom and bust  

What causes economies to grow? One of the problems with analysing the trends of the last 10 years is that, in future, the global economy will be divided into two eras: pre-2008 and post-2008. We are now all personally familiar with the experiences of boom and bust but the telecoms industry acquired first-hand knowledge of the phenomena earlier, staging its own bust in 2001/02. This accompanied the largest bankruptcy in history at that time (Worldcom) and the most notorious (Enron). Yet economically the era between 2000 and 2010 is hardly exceptional in the long march upwards of global GDP: boomand- bust asset bubbles such as the Tulip Mania of 1636 (in which a single bulb was sold for four oxen, a bed, a suit of clothes and “one thousand lbs of cheese”) are not rare, but are blips. According to some historians, the Tulip Mania was even closer to our own boom-and-bust cycles, as the deals were struck out of season by men in bars who didn’t own the bulbs. They were, essentially, bets placed on the future options prices. It was either a drinking game or a derivatives market, depending on where you stand on derivatives.

However, the effects of a strong telecommunications infrastructure on GDP’s long march are clear (and positive). Pantelis Koutroumpis of Imperial College Business School, in his paper “The economic impact of broadband on growth,” (Telecommunications Policy, 2009) uses evidence from 22 OECD countries over six years to find the correlation between GDP growth and telecoms infrastructure. The results are dramatic: “Given that these countries have grown at a compounded annual growth rate of 4% for the period 2002-07, our fixed-effects estimate implies that about 9.8% of the growth can be attributed to the high-speed internet service and telecommunications industry,” he says.  

Periods of growth: Glocal GDP 

According to the World Bank, in 2000 global GDP was $32 trillion; by 2008, it had reached $61 trillion. The thrilling rise in global GDP may have slowed down in the last two years, but it has some profound consequences. The most important is the origin of the growth. If you use purchasing power parity as your measure, half of global GDP is now produced in the developing world; those economies are growing about twice as fast as those in the developed world, and so even if it’s all converted into dollars, there will be equality around 2014. As investors recover from the global recession, and see which countries escaped largely unscathed, their investment patterns may change as a result.

Jerome Booth, a former academic economist and co-founder of the Ashmore Group, points out that investing in developing economies is no longer simply a high-risk, high-return strategy. It has become essential. “We have to rethink asset allocation. All countries are risky, but emerging markets are the ones where that risk is priced in.” His conclusion is that too much investment is still placed in the developed world because it has traditionally been thought of as risk-free, and so comparatively low returns have been considered acceptable. Booth takes the contrary view: for his investors, he recommends that if they are less than 50% invested in assets in developing markets, they are underweight in that area.  

Adjustments: cities

The dominant demographic trend from the last 50 years, which shows no sign of slowing down, is urbanisation. In 1900, 13% of the global population lived in a city. In 2000, there was still a slim majority of the world’s population living outside cities. According to the UN World Urbanisation Prospects report, that changed in around 2007, with projections claiming that more than 60% of the global population will be urban dwellers by 2030.

It’s not just the movement to cities that is significant, but the type of urbanisation that we are experiencing. Cities have always developed in a chaotic way, but the accelerated pace of migration in the developing world is creating cities like Sao Paulo or Delhi, in which the existing urban centre is surrounded by informal settlements. Those settlements have few facilities and little chance of creating them, as there is no role for a central planner.

Yet the difficulty in investing in unplanned urban development masks the need for it. The urbanisation of China is often presented as a series of government-directed high-rise city-centre developments, built with next-generation telecommunications at its heart. Yet – as Li Zhang of Fudan University in Shanghai points out in China’s informal urbanisation: conceptualisation, dimensions and implications, 2009 – “urbanisation from below” in the 1990s “generated one-third of the country’s GDP, contributed 40% of the country’s exports and provided over 90% of rural non-agricultural employment.”

In most cases, there is little obvious incentive for telcos to provide service to the urban poor, except to sustain growth once other markets are exhausted. The liberalisation of telecoms has removed the commitment to universal service provision and replaced it with a different type of barrier: affordability. Ana Maria Fernandez-Maldonado at Delft University of Technology studied the effect of the deregulation of water and telecoms in the slums of Lima in 2007; she found an effect of liberalisation that is common across many developing countries: “The reforms have led to universal coverage, but the financial accessibility of the poorest households to these services has worsened... In this way, the most important goal of the reform has not been achieved.”  

Adjustments: mobility and the brain drain  

Scanlon’s concept of migration was that a small number of his customers moved outside their home state in their lifetimes. Today, entire industries can migrate across continents. Globalisation is credited (or blamed) for a shift in employment and growth from the developed world to India, China and other developing economies, but it has also had the effect of creating a shift in migration from those economies to the universities and workplaces of the developed world.

An example is the growth in a decade of NRIs – non-resident Indians – who have traditionally been economic emigrants. This has created a demand from the government and from businesses alike to attract them back. Fuelled partly by the lack of technically-able senior executives, Indian salaries for professionals jumped by 14% in 2007 and by a further 15% in 2008, according to Employment Conditions Abroad, an association for global HR professionals.

The traditional way to look at skilled worker migration is as a “brain drain” – that poorer countries stay poor because, for example, the most talented network engineers move to California. Recent economic research challenges this: both the least educated and highly-educated emigrants are more likely to return, and the highly-educated emigrants have valuable skills.

Andrew Mountford and Hillel Rapoport, economists based in the UK and Israel, challenge this idea in research entitled “The brain drain and the world distribution of income”, published in 2010. “Skilled emigration (or brain drain) from developing to developed countries is becoming the dominant pattern of international migration today,” they write. “Emigration rates in 2000 were three times higher than average for the highly educated and skilled – and 12 times higher among emigrants from low-income countries.” But the net effect is not so clear cut.

As long as countries are developing globalised business – such as China, India, Indonesia or Brazil – Mountford and Rapoport conclude that the brain drain might not be a bad thing for the countries being “drained”. Due to the increased wealth of the emigrants sent home, the reduction in surplus workforce and the measures taken to stop the drain, they claim, “Brain drain migration will accelerate the rate of convergence of the main globalisers, at least in the short run.” By “convergence”, they mean the rate at which the economies “catch up” with the developed world. Some economists believe that convergence occurs as a result of technological sophistication. Others believe that convergence in the long run is inevitable – for example, because investment capital flows to regions which can produce a better return. Those regions are usually less developed or have customers whose wealth is increasing quickly. 

Adjustments: unconnectivity  

An area of economic thinking that was inspired by telecommunications, network effects have never been more important. The idea that a network’s power is the square of the number of people attached to it was first presented in a paper by N Lytkins in 1917, an employee of Bell Telephone. The idea suited Bell’s attempt to create a monopoly, but has influenced thinking not just directly (the internet, open standards), but indirectly too (internet governance, wholesale telecommunications). So much so, that it’s commonly assumed that things naturally become more connected over time.

But we also understand that, in the words of Kevin Werbach, a professor at the Wharton School: “There’s a certain point at which several clusters of not-connected networks come together. The problem is that process works in both dimensions. There’s a fundamental tension – the networks that are most efficient, which provide the most value to the people using them, tend to not be stable. There are forces that let some nodes in the network become more powerful, and the other nodes don’t want to be beholden to those nodes, and they try to split off.”

Mathematically, there’s no reason that the trend towards increased interconnectivity and interdependency is a one-way street. Economically this may be true for a period of time, but not for ever. We have gone through a decade where network effects dominated, but the debate about the longterm viability of network neutrality on the internet has been going on since before 2000, and will continue for some time yet. The trend – which at first seems quite the opposite of the dominant economic forces in telecoms – for a “reverse network effect” is already in evidence in some of the fastest-growing segments in the industry. The “Skype effect”, proprietary smartphone apps, teleconferencing networks and content delivery networks are examples of the economic value of not being connected to everyone.

The economic value, in turn, comes from the fact that they produce their own network effects that cement Balkanised mini-networks: for example the strength of the influence of peer selection on telecommunications products from your mobile phone tariffs (call your mates for free), to enterprise video conferencing device selection (you can call them, full stop) continues to inspire the successors of N Lytkins to research. Lytkins himself might have been less enthusiastic on behalf of his employer had he foreseen the impact on peer-to-peer internet traffic, the biggest network effect of all.