Telecommunications industry and economic growth: How its ... · Vahagn Jerbashian (CERGE-EI) DEGIT-XVI, St. Petersburg, Russia, September 8-9, 2011. Motivation and research Outline

Motivation and researchOutline of results/contributions

Methodology/The modelResults/conclusions - 1Results/Conclusions - 2

Telecommunications industry and economicgrowth: How its market structure matters

Vahagn Jerbashian

CERGE-EI

September 8, 2011

Vahagn Jerbashian (CERGE-EI) DEGIT-XVI, St. Petersburg, Russia, September 8-9, 2011



Motivation - Empirical and theoretical resultsMotivation - PoliciesObjectives - Growth, market structure, and policiesTelecom features - Products, market, and firmsTelecom features - Investments and innovationTelecom features - Network externalities

Motivation - Empirical and theoretical results

Empirical studies suggest that the telecommunication industry(telecom) has a significant contribution to economic growth

Emphasized channels: infrastructure investments; network externalities

e.g., Roller & Waverman (2001); Czernich, Falck, Kretschmer, &

Woessmann (2011)

The literature suggests that the market structure of an industrycan matter for its contribution to economic growth

Emphasized channels: innovative activities; ineffi ciencies stemming from

imperfect competition

e.g., Nickell (1996); van de Klundert & Smulders (1997); Aghion, Bloom,

Blundell, Griffi th, & Howitt (2005)





Motivation - Policies

Many recent policies propose changes in the market structure oftelecom and have initiated such changes already

e.g., the Telecommunications Act of 1996, in the US; thedirectives 90/388/EEC, 96/19/EEC, 2002/22/EC, and2002/58/EC in the EU





Objectives - Growth and market structure

This paper analyses how the market structure of telecom mattersfor its contribution to long run growth in terms of innovation byincumbents and entrants; and

shows how the competition type in telecom market can matterfor that contribution;

suggests the direction of policies that can deliver higherwelfare in the decentralized equilibrium;

evaluates several implications of the recently implementedpolicies;

focuses on the productivity improvement in telecom





Telecom features - Products, market, and firms

Telecom firms

produce imperfectly substitutable products (e.g., wireless andland-line services)

operate in monopolistic environment

are known to be relatively large and long lasting firms

e.g., Vodafone was created in 1983 and in 2011 its marketvalue is $148bln





Telecom features - Investments and innovation

Telecom firms

carry substantial investments before the entry to the markets

e.g., they build infrastructure in order to provide their services

enhance their productivity through continual investments,after the entry

e.g., digitalization of networks

engage in R&D partnerships and cross-licensing activities(Hagedoorn 1993; 2002)





Telecom features - Network externalities

The products of telecom firms create two types of positive networkexternalities amongst their users (Gandal, 1995)

Direct Network Externalities increase the value of using atelecom good with the number of users

In the light of productivity improvement in telecom, the"number of users" is replaced by "effective number of users"

Indirect Network Externalities stem from existence ofdifferent types of telecom goods, given that a user of atelecom good can access other telecom goods also




Results - Market structure, welfare, and growth (1 from 2)Results - Market structure, welfare, and growth (2 from 2)Results - Market structure/entryResults - Policy discussion/theoretical recommendationsResults - Policy discussion/substitutability

Results - Market structure, welfare, and growth (1 from 2)

In decentralized equilibrium

the market structure of telecom matters for social welfare dueto imperfect competition in telecom market

the demand for telecom goods is lower (compared with the sociallyoptimal one), while the productivity improvement in telecom goodsis one of the drivers of economic growth





Results - Market structure, welfare, and growth (2 from 2)

In decentralized equilibrium, when there is finite number oftelecom firms,

changing the market structure or the toughness of the competition(Cournot vs. Bertrand; Sutton, 1991) affects the productivityimprovement in telecom and the demand for telecom goods

increasing the number of firms or toughening the competitionincreases the social welfare





Results - Market structure/entry

Depending on economy, there are two cases in decentralizedequilibrium

the entry to telecom either stops after some number of firmshave entered

endogenous barriers to entry

the entry continues forever

monopolistic competition, in long run

In social optimum

there is permanent entry





Results - Policy discussion/theoretical recommendations

The results suggest that the policies which can improve the welfarein decentralized equilibrium

subsidize the production of telecom goods (or the demand)

allow free entry and subsidize it, if needed, in order toguarantee permanent entry

subsidize the investments for productivity improvement

the last two points tend to be overlooked in the recentlyimplemented policies (e.g., the Telecommunications Act of1996)





Results - Policy discussion/substitutability

Recently implemented policies may have increased thesubstitutability between telecom goods

e.g., the Telecommunications Act of 1996 mandates numberportability and motivates interconnectedness

(i) this type of policy is not in-line with social optimum, wherelower substitutability implies higher welfare

(ii) in competitive equilibrium its effect is ambiguous, when thereare no exogenous barriers to entry

(iii) in case of exogenous barrier to entry (and exit) increasing thesubstitutability can deliver higher GDP growth rate

thus it may deliver higher welfare




MethodologyFormalizationFinal good production sideTelecom - Telecom good productionTelecom - Firm entryHousehold side

Methodology (1 from 2) - The type of the framework

This paper uses a general equilibrium framework

it can explicitly suggest how the telecom can affect the growth

it can suggest the general equilibrium effects of policies





Methodology (2 from 2) - Important building blocks

Most notably, the framework developed in this paper incorporates

firm entry to telecom market

in order to endogenize the market structure of telecom

innovation in telecom by incumbents

trade of patents (production instructions; knowledge forproduction) in telecom

stands for R&D partnerships and cross-licensing

direct network externalities

not endogenous; do not drive the main results of the paper





Multi-sector endogenous growth model for telecom

Two sectors

Final good sector

Final good producers produce a homogenous good Y , which isthe numeraire good

Telecom

Each telecom firm produces a distinct type of telecom good x





Final good production side

The representative producer’s problem:

maxY = X µX σL1−σY

s.t.

X =

(N∑j=1x

ε−1ε

j

) εε−1

µ > 0, ε > 1, σ ∈ (0, 1)in equilibrium X = X





Telecom good production

Given the (inverse) demand of telecom good the jth(∀j = 1, ...,N) producer’s problem is

maxCournot : Lxj ,Lrj ,{uj ,i ,ui ,j }

Ni=1;(i 6=j)

Bertrand : pxj ,Lrj ,{uj ,i ,ui ,j }Ni=1;(i 6=j)

Vj (t) =∞∫t

πj (τ) exp[−

τ∫tr (s)ds

]dτ

s .t.

πj = pxj xj +N∑

i=1,i 6=jpuj ,iλj

(uj ,iλj

)−(Lxj + Lrj

)w −

N∑

i=1,i 6=jpui ,jλi

(ui ,jλi

),

xj = λjLxj

λj = ξ

[N∑i=1

(ui ,jλi

)α]

λ1−αj Lrj ; uj ,j ≡ 1, ξ > 0, 0 < α < 1





Telecom - Firm entry

The entrant borrows the resources for entry investment Sfrom household with the interest rate r .

The investment is in terms of final good and has itsproductivity η.

The creation of the distinct type of telecom good is given by

N = ηS

η > 0





Household side

A continuum of identical and infinitely lived households of massone

Each household is endowed with constant amount of labor, L

Household’s optimality problem:

maxU =

∞∫0

C 1−θt

1− θe−ρtdt

s.t.

A = rA+ wL− Cθ > 0, ρ ∈ (0, 1)




Results - Exogenous barriers to entryResults - Endogenous entryResults - Endogenous entry case 1 (1)Results - Endogenous entry case 1 (2)Results - Endogenous entry case 2

Results - Exogenous barriers to entry

Economic growth is higher if the number of telecom firms is higherand/or the competition is tougher in any of telecom markets(Cournot vs. Bertrand; Sutton, 1991)

g - GDP growth rate; L - Lerner index(1) - Bertrand competition; (2) - Cournot competition





Results - Endogenous entry

Depending on household’s preferences and production technologiesthere are two cases in the economy

Case 1 —endogenous barriers to entryCase 2 —permanent entry





Results - Endogenous entry case 1 (barriers to entry)

The number of telecom firms is finite and constant; it can bederived from a zero profit condition

Under Bertrand competition

NB = (ε− 1)ξL− ρ

σ

ε(ξL− ρ

σ

)− ξL [(θ − 1) (σ+ µ) + 1]

Under Cournot competition

NC = (ε− 1) ξL [(θ − 1) (σ+ µ) + 1]

ε(ξL− ρ

σ

)− ξL [(θ − 1) (σ+ µ) + 1]





Results - Endogenous entry case 1 (barriers to entry)

Telecom contributes to economic growth through productivityimprovements in telecom good production

Economic growth increases with the scales of direct networkexternalities





Results - Endogenous entry case 2 (permanent entry)

On balanced growth path

there are infinitely many telecom firms

telecom contributes to economic growth through theproductivity improvements in telecom good production andthrough growth in the number of telecom firms

toughening the competition and increasing the number oftelecom firms does not affect economic growth

economic growth increases with the scales of direct networkexternalities




Results - Competitive equilibrium vs. social optimum (1)Results - Discussion of policies

Results - Competitive equilibrium vs. social optimum

Due to price setting behavior of telecom firms and the directnetwork externalities the market price of telecom good is notequal to its marginal value (and cost)

In competitive equilibrium there is under-investment inproductivity improvement

In addition, the returns on investments decline with entry offirms in competitive equilibrium, in contrast to social optimum

In social optimum there is permanent entry, in contrast to thecompetitive equilibrium where there can be endogenousbarriers to entry




Results - Competitive equilibrium vs. social optimum (1)Results - Discussion of policies

Results - Discussion of policies

The policies that deliver socially optimal allocations as acompetitive equilibrium outcome

subsidize the production of telecom goods (or tax the demand)

subsidize the investments for productivity improvement

allow free entry and subsidize it, if needed, in order toguarantee permanent entry

Policies which increase the substitutability between telecom goodsare not in-line with social optimum


Documents

Telecommunications industry and economic growth: How its ... · Vahagn Jerbashian (CERGE-EI) DEGIT-XVI, St. Petersburg, Russia, September 8-9, 2011. Motivation and research Outline