Chapter 2 Literature Review
2.1 Theoretical Foundation…
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Chapter 2 Literature Review
The content of literature review in this chapter will be covered the direct effects and empirical observations of telecommunications development on economic growth.
2.1 Theoretical Foundation
The issues of economic growth related to telecommunications development have become items in macro environment and national
economic since it is one of the major forces to drive the goal of developments in economic growth in the national market place (Rabayah, Awad and Naser, 2008). According to OECD’s report (2004), telecommunications infrastructure developments play an important role in modern economies as in new
economic activities. It becomes more efficiency, and social and economic welfare are enhanced for all stakeholders in an economy via positive externalities as regulatory reforms take effect. Furthermore, Oyedemi and Gillis (2004) came up with the several ways from the point of view of telecommunications in which it can influence economic growth:4 I. Reduction of Regional Infrastructure and Development Gap
One of the reasons for the persistent gap between rural and urban areas in any country is the telecommunications infrastructure gap, which results in the information gap between rural and urban areas. Governments and other financially able parties should establish communication technology links to
4 Oyedemi, T
.and Gillis, B., “Macro Environment and Telecommunications 2004: Direct Effects of Telecommunications on Economic Development, ”Telecommunications and Social development.
http://cbdd.wsu.edu/kewlcontent/cdoutput/TR501/page66.htm
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facilitate information transmission.
II. Telecommunications as an Input to the Economic Production Process Telecommunication services in any business entity are to some extent a low cost substitute for information handling labor for helping the industries more by increasing the productivity of each of these traditional inputs and thus increasing the efficiency of the entire production process.
III. Market Efficiency Effect
Telecommunications increases not only the efficiency of market
operations by facilitating information flow, but also arbitrage opportunities in financial markets, which in turn lower the capital costs of production.
IV. Spillover and Externality Effects
In addition to its direct contribution to end-subscribers, the
telecommunication networks generate significant spillover effects in other sectors of the economy. By possessing the characteristics of infrastructure capital, telecommunication networks generate substantial externalities both on the supply side and on the demand side.
V. Coordination of Economic Activity
Telecommunications help in the coordination of economic activity by allowing easy acquisition and transfer of information among economic units.
At the aggregate economy level, telecommunications helps social planners to coordinate different economic activities at reduced communications costs.
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VI. Global Telecommunication Connections
Global telecommunications can influence the global economy through similar mechanisms for helping the rapid movement of information from one country to another and allow optimal utilization of available technology, products and services around the world, thus helping to improve the global economy.
From the economic point of view, telecommunications development can lead to economic growth through both direct and indirect channels. The importance between economic growth and telecommunications development can be appropriately evaluated in the frameworks of growth theories.
Neoclassical Growth Theory
In the neoclassical model5 which was developed by Ramsey (1928), Solow (1956), Swan (1956), Cass (1865) and Koopmans (1965), there is a constant return to scale aggregate production function with substitution between capital and labor (Ding, 2005). One feature of this model is the convergence property: the lower the starting level of real per capita GDP and the higher is the predicted growth rate which derives in the model from the diminishing return to capital (Barro, 1997). It leads the growth process within an economy to eventually reach the steady state where per capita output, capital stock, and consumption grow at a common constant rate equaling the exogenously given rate of technological progress as a primary source of growth (Islam, 1995). Islam also mentioned that there are three important
5 Antonietta Campus (1987) mentioned that Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often as mediated thro
\ugh a hypothesized maximization of income-constrained utility by individuals and of cost-constrained profits of firms employing available information and factors of production, in accordance with rational choice theory.
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predictions of neo-classical model.
First, increasing capital relative to labor creates economic growth, since people can be more productive given more capital.
Second, poor countries with less capital per person will grow faster because each investment in capital will produce a higher return than rich countries with abundant capital.
Third, because of diminishing returns to capital, economies will eventually reach a point at which no new increase in capital will create economic growth. This point is called a "steady state". The steady state income level is determined by the country’s saving and labor force growth rates, and some of other parameters of technology.6
The concept of capital in this model can be use-fully broadened from physical goods to include human capital in the form of education with a steady state ration of human to physical capital. Thus, regional economic growth differences can be interpreted as availability and mobility of capital and labor inputs in the short run. Liu (2008) cited Clark’s argument that availability and quality of infrastructure has the determinative force in interregional production factor movements. Furthermore, Barro and
Sala-i-Martin, 2004) pointed out that the production function is combined with a constant-saving-rate rule to generate an extremely simple
general-equilibrium model of the economy.
Ding (2005) revealed that while technological change is the one of primary growth sources, telecommunications can be regarded as this kind of general purpose technology and infrastructure. Given the direct and indirect channels through which telecommunications infrastructure functions in the
6 http://en.wikipedia.org/wiki/Economic_growth
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production process, these communications networks can be taken as a type of capital input and modeled in Solow’s neoclassical economic growth model which is criticized as not accounting for fixed effects and appropriate
causalities and correlations (Ding, 2004).
Endogenous Growth Theory
Endogenous growth theory is a response to criticism of the neo-classical growth model.7 This approach provides a theory of technical progress as one of the central missing elements of the neoclassical model that is the major difference between the endogenous growth model and the Solow aggregate production function approach lies in the endogeneity of technical changes (Liu, 2008). In neo-classical growth models, the long-run rate of growth is exogenously determined by either assuming a savings rate (the
Harrod-Domar model) or a rate of technical progress (Solow model).
However, the rate of saving and technological progress remains unexplained.
Endogenous growth theory tries to overcome this shortcoming by building macroeconomic models out of microeconomic foundations. The existence of increasing returns to scale in the aggregate production function is a novelty in the endogenous growth theory. Technological change is treated as a separate factor in the aggregate production function as
endogenous economic phenomenon has increased dramatically (Ding, 2005).
The engine for growth can be as simple as a constant return to scale
production function (the AK model) or more complicated set ups with spillover effects, increasing numbers of goods, increasing qualities, etc.
According to the endogenous growth theory, telecommunications
7 http://en.wikipedia.org/wiki/Endogenous_growth_theory
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development shift from the incentive to accumulate physical capital to incentive across regions. Because networking is characterized by positive economic externalities related to diffusion and accumulation of the
knowledge, stock can be achieved through investment in telecommunications infrastructure development. Waverman, Meschi and Fuss (2005) also
explored the impact of telecommunications rollout on economic taken by the endogenous technical change approach that Investment in
telecommunications generates a growth dividend because the spread of telecommunications reduces costs of interaction, expands market boundaries, and enormously expands information flows.