Demand for telecommunication services in developing countries

Abstract

Living standards and economic growth in developing countries are invariably linked to the availability and use of telecom services. Effective policy decisions require the best estimates of the drivers of these services. In this paper, telecommunications demand is estimated in models for residential mainline and mobile telephone service for developing countries for the period 1996–2003. The paper tests for cross-price effects between mainline and mobile service and its findings have important policy implications. It finds residential monthly price elasticity to be insignificant for developing countries, but the connection elasticity is larger than generally found in the literature. Mobile monthly price elasticities are very large. A new and important empirical finding is that although wireline phones are substitutes in the mobile market, the contrary is not true—mobile phones are not substitutes in the wireline market, and in fact may be considered complements. This lack of symmetry has important implications for properly defining telecom markets. Universal service subsidies and competitive market initiatives should be reevaluated in light of the paper's elasticity estimates. Increased competition, income growth and enhanced education may be the ultimate universal service promoters.

Introduction

The privatization of British Telecom, the opening of competitive markets in United States long-distance services and the technological dynamics of telecommunication have provided examples to the developing world of possibilities for the future. Privatization swept the world and competition was introduced in many countries, especially in mobile markets. The movement from state monopolies to privatized telecommunications firms, the introduction of competition where none existed before and the rise of mobile service invite a comprehensive examination of the changing worldwide telecommunications market. Privatization of state telecommunications monopolies may create opportunities not previously available in countries where state monopolies did not expand and improve basic service, or provide advanced services. Theory suggests that competition will allow markets to expand as firms compete to capture market share by driving prices down, expanding service options and/or raising quality—even in the poorest regions (see Fink, Mattoo, & Rathindran, 2002; Hart, 1983; Megginson & Netter, 2001; Nickell, 1996; Petrazzini, 1995; Schleifer, 1998; Vickers & Yarrow, 1998).

Privatization of a state monopoly can result in improvements in service quality and options, but there are concerns. In the absence of competition, managers have an incentive to maximize profits if they share in the rewards. This may result in productive efficiency as the organization is restructured to cut costs, but many newly formed regulatory agencies may be incapable of effectively controlling incumbent market power to the customer's detriment. There is the additional issue of regulatory price distortions (cross-subsidies) and rules that inadvertently favor some segments of the industry over others. Privatization of state monopolies in combination with competitive entry may be the best solution to achieve productive and allocative efficiency and, ultimately, disciplined prices (see Kay & Thompson, 1986). Reform efforts clearly favor privatization and increased competition for their ability to attract the massive amount of capital necessary to meet the needs of growing telecommunication networks globally (see FCC, 1999). How to promote competition so that it exists in the short and long run may be problematic where market power is an issue. Luckily, the telecommunications area with its technological dynamism is an industry that exhibits all the characteristics of continuing long-term competition.

Ros (1999) is the first empirical work on the impact of privatization and competition (1988–1995 data). His study shows that privatization is an important factor in expanding the mainline network but competition has no impact (probably because competition was not in place in many countries in 1995). Wallsten (2001a) finds that mainlines expand where competition exists in developing countries but privatization by itself has few benefits. An independent regulator variable interacted with privatization has a positive impact on mainline penetration. However when the independent variable is interacted with competition there is no effect. Wallsten (2004) investigates the impact of exclusivity rights of newly privatized telecommunications firms in developing countries. These rights tend to increase price and reduce investment and penetration. Recent work by Li & Xu (2002), Li & Xu (2004) suggests that privatization and competition are important factors in the development and expansion of both fixed and mobile telecommunications for a sample of 172 countries over the period 1988–2001. However, they do not incorporate price data over this period, which are required to estimate telecommunication demand models. Garbacz and Thompson (2005) estimate separate demand models for developed and developing countries with data from 1996 to 2001. Competition and privatization variables, however, were not included in their models.

For a properly specified model of telecommunications demand, the authors combine the Li and Xu (2004) data on privatization and competition into the price equations of overall demand models for fixed and mobile service developed by Garbacz and Thompson (2005). They also add a binary variable indicating the presence of an independent regulator, which, if present, could have appeared prior to or following privatization. These models use panel data from the World Bank and the International Telecommunication Union (ITU). The results allow a sophisticated interpretation of the impact of competition, privatization and regulation, and telecommunication prices on service usage. Public policy issues relating to universal service and service expansion in general can be evaluated in view of the results of these new models. For the most part, the issues addressed are empirical in nature. For example, there is the impact of privatization and competition in expanding service markets, and the crucial issue of whether fixed and mobile telephony are substitutes or complements.

The growth of mobile telephony relative to that of mainlines (fixed lines) for the period 1995–2004 is clearly shown in Table 1. Developing countries tend to have high and growing mobile to fixed-line ratios when compared to most developed areas, due, in part, to much lower levels of mainlines in 1995. By 2002, there were more than one billion mobile subscribers worldwide, a number that for the first time exceeded the number of fixed lines in service in that year.