TELECOMMUNICATIONS AND ECONOMIC GROWTH

IN COUNTRIES IN TRANSITION
Darko DVORNIK
Assistant Minister, Ministry of the Sea, Tourism, Transport and Development,
Prisavlje 14, 10000 Zagreb, Croatia
darko.dvornik@mppv.hr

Dubravko SABOLI
HEP Transmission System Operator Ltd, Kupska 4, 10000 Zagreb, Croatia
dubravko.sabolic@hep.hr

Abstract:
Developed and widely available telecommunications services are regarded as key
enablers of the new economy. In East European countries in transition
telecommunications investments are generally perceived as a stimuli for economic
growth acceleration. We will try to investigate this empirical correlation and Granger
causality between certain indicators of telecommunications sector activity, and economic
growth. The indicators comprise total investments in the telecommunications sector, as
well as other natural parameters, such as various penetration rates of services. We also
propose additional indicators which may describe telecommunications sector
development better than traditional fixed telephony based measures. This is due to
significant migration of users from fixed to mobile networks, and from basic to
broadband Internet access in the last few years. In the near future one can expect
broadband Internet users also to move to mobile network infrastructure.

Keywords: Transition countries, telecommunications and economic development.

Introduction
The development and functioning of a telecommunications system presents an inevitable
factor in the functioning of national and global markets, in particular in transition
countries where there traditionally existed an imbalance between the telecommunications
supply and demand. This is primarily due to non-functional market mechanisms, although
there were some other equally important reasons.
Slow development along with the insufficiently developed telecommunication
infrastructure and services in transition countries may be a restrictive factor in the process
of opening towards countries with a developed market economy, but may also become
the main obstacle to the acquisition of new knowledge, to international trade, and sources
of financial capital.
The large gap in the telecommunications development between developed and
undeveloped countries is increasing in spite of the existing different international

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programs aimed at the stimulation of construction and use of telecommunications
infrastructure and services, and in spite of the increasing possibilities and capacities of
telecommunication equipment, and prices (as per the amount of transferred information
in relation to processing speed) that are at the same time becoming lower. On the other
hand, efforts are geared towards opening markets and privatization in order to attract
sufficient capital from the private sector for further telecommunications development.
Those transition countries which rapidly reorganise and develop their
telecommunications infrastructure and networks and introduce new and innovative
services will thus create more opportunities for economic growth and progress.
Modern society is rapidly developing as an economic system based on continuous and
established exchange of information. Countries and economic sectors which have the
necessary telecommunications infrastructure and services are better prepared for post-
industrial, information based economic growth.

Telecommunications and transition countries

Up until twenty years ago, the European and other telecommunications markets were
almost identical. There were telecommunications operators, incumbents which offered
traditional telecommunications services (in the first place voice and data transfer
services) via the fixed telecommunications networks. Similar situation existed in East
European transition countries as well, with the difference being that the level of
development of telecommunications networks significantly lagged behind West European
countries, while the number of telephone connections in these countries was lower than in
the worst developed West European countries..
One of the main causes for the delay in development is that in West European countries
the functioning market created the need for more extensive and free exchange of
information on market activities.

Table 1. Comparison of telecommunications development measured by penetration ratio

in 1990. Source: ITU and authors.

Penetration rate (%)

Average East European Transition Countries 14
Average West European Countries 45.1

Transition countries have a lower share of income from telecommunications in GDP,

which shows the lack of representation of telecommunications in the national economy,
that is, the lagging behind in development (Welfens, 1995).
Groups of countries in which competition in the telecommunications market existed had a
considerably larger share of the income from telecommunications in GDP as opposed to
countries which still ran a monopoly.
Developed countries have high income per telecommunications access point which
corroborates the fact that the demand in transition countries was insufficiently satisfied.

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This is substantiated by the fact there were long waiting-lists for telephone service.
(Welfens, 1995).
Due to strictly regulated state national telecommunication operators, there was a large
imbalance between supply and demand for telecommunications services. Demand for
telephone service (access points) by far exceeded the supply offered by the incumbent in
the national market.
Income from national operators was de facto state income, which meant that only a small
part of funds was reinvested into telecommunications on the basis of the governments
political estimate, and not the actual market needs.
There are a few reasons why transition countries did not sufficiently invest in their own
national telecommunications networks.
Furthermore, comparative studies conducted in the 1980's have shown that, according to
the majority of indicators, social cohesion (on local, regional and national level) in
socialist countries was much weaker than in western societies and economies (Welfens,
1995). The prevention of usage of communications media and free information flow was
widely acknowledged as an important factor in the weakening of social cohesion. Also, it
contributed to the syndrome of less freedom and independence in societies which
transition countries would eventually need to overcome.
Such disrupted market relations eventually resulted in prices of regular telephone services
in local traffic being considerably lower than in West European countries, but the huge
unsatisfied demand for these services annulled the actual presence of low and uniform
prices for local calls. International telephone traffic was also poorly developed due to the
low quality of the network, low quality and insufficient digitalization, which not only
reduced individual communication, but rather prevented trade expansion, international
investments and global business communication in general.
Traditional political resistance to the broadening of the economic and communication
East-West relations was natural for socialist countries, which, after the 1980's, changed
towards a market-oriented decentralized economy, was identified as the critical problem
for economy transformation.
In a decentralized economy where millions of companies and individuals are allowed to
make autonomous decisions, there is a considerably larger need for communications and
information than was the case in a centralized economy. The underdeveloped
telecommunications infrastructure and services may slow down the desired economic
opening towards countries with market economy, and become a main barrier to the
acquisition of new knowledge, international alliances and financial resources.
Fast and balanced development of telecommunication infrastructure and services in
transition countries is extremely important for:
Modernization of economy through the strengthening of competitive positions and
easier integration into the world economy,
Avoidance of marginalization of any segment of society or region, and their complete
opening towards challenges and opportunities of the competitive market economy.
The modern developed telecommunications sector is of vital importance for achieving
international competitiveness, especially in the trade sectors, which has a positive
influence on economic development. Transition countries which accelerate the
reorganisation and development of their telecommunications networks and introduce new

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and innovative telecommunications services will have better chances for economic
growth and progress.
The expansion of the telecommunication sector is connected with economic growth, but
the development of the sector is, at the same time, a stimulus for economic growth
(Welfens, 1995).

Telecommunications markets development indicators

A combined indicator of the development of fixed telecommunications services by means
of indicators of penetration rate (number of users per every 100 inhabitants) was
frequently used in the past research and assessment of the degree of telecommunications
development.
Generally speaking, penetration ratio, viewed as a measure of development of the
telecommunications market services in statistical publications and professional literature,
is measured in percentages, and is calculated in the following way:

number of telecommunication service users

PEN = 100%. (1)
total number of inhabitants

In the last fifteen years, due to the technology boom, more favourable economic
characteristics of telecommunication systems and networks, and successfully
implemented regulatory reforms, new telecommunications services (networks) appeared
which achieved significant market success, such as mobile telecommunication networks
and Internet services.
For the purpose of an adequate comprehensive overview of the development of the
overall telecommunications market, it is necessary to divide the telecommunication
market to suitable markets of individual ( most developed) telecommunications services.
Therefore, in this article, the following three most developed telecommunication markets
will be analyzed:
Fixed telecommunications services market,
Mobile telecommunications services market, and
Internet services market.
Similarly to (1), we can define the indicators of the three most developed segments of the
telecommunication markets:
Fixed Telecommunications Services Market PENn

number of fixed telecommunication service users

PEN n = 100%. (2)
total number of inhabitants

Mobile Telecommunications Services Market PENm

number of mobile telecommunication service users

PEN m = 100%. (3)
total number of inhabitants

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Internet Services Market PENi

number of Internet service users

PEN i = 100%. (4)
total number of inhabitants

Weighted indicator of the degree of development of the overall

telecommunications market
Two things need to be taken into consideration when deciding what an indicator of
overall development of the telecommunication market should comprise. First, what are
the data that best describe the phenomenon which we want to quantify? Second, is the
data accessible and how reliable is it? There are many things which can more or less be
measured.
In modelling the total indicator for the development of the telecommunications market,
we take into account only those telecommunication markets i.e. services which are
offered on a sufficiently wide basis in observed countries and which correspond to
today's (basic) communication needs. Therefore, we will consider all three of the
aforesaid, widely defined, market categories.
The indicator of development of the fixed telecommunications services market for
decades has been monitored by the International Telecommunications Union (ITU) and in
past research has been mostly used as the main indicator of the development of the
telecommunications market. The development of mobile telecommunications services has
been observed since the 1990's. In less developed countries, mobile telecommunications
represent a substitute for the fixed telephone service network, while in developed
countries they represent an upgrade to the fixed network. The development of Internet
services market has also been observed since the 1990's with the main reason being the e-
mail service and boom of the Internet telephony (IP telephony).
In relation to the aforesaid, the overall development of the telecommunications market
may be shown as the sum of the indicators of the development of fixed
telecommunication services markets (PENn), indicators of the development of mobile
telecommunication services markets (PENm) and indicators of the development of the
Internet services market (PENi):

PENABS = PENn + PENm + PENi, (5)

where PENABS stands for absolute penetration ratio.

One of the problems that arise from this approach in the determination of the degree of
overall development of telecommunications market is the possibility of overlap. For
example, a user may have a few mobile telephones or may use certain services e.g. voice
service via all three telecommunications markets.
The problem is that the data on the number of such overlaps on the global level is not
monitored by anybody, except for the operators themselves who offer these services, and
have insight into the database of their users and their features, which is a business secret.
Furthermore, the appearance of overlaps is evident for example in West European
countries, since such markets have a well developed fixed telecommunications market,

916
and the mobile telecommunications network represents a substitute service to the fixed
telecommunications network.
For those reasons, such indicator of the degree of development of the overall
telecommunication market referred to in point (5) will no longer be used in this article.
In order to solve the aforesaid problems, it is necessary to create an indicator of the
development of the telecommunications market that will, in addition to being more
comprehensive and including all larger markets of telecommunications services, in a
suitable way eliminate the problem of overlap in individual telecommunications
services markets.
The previous formula for the overall development of telecommunications services given
under (5) may be replaced by the following:

n PEN n + m PEN m + i PEN i

PEN PON = (6)
n + m + i
Where:
Trn Trm Tri
n = ; m = ; i = ; Tr = Trn + Trm + Tri
Tr Tr Tr
PENPON Weighted indicator of overall telecommunications market development;
n Weight factor of the fixed telecommunications services market;
m Weight factor of the mobile telecommunications services market;
i Weight factor of the internet services market;
Trn Revenue from the fixed telecommunications services market;
Trm Revenue from the mobile telecommunications services market;
Tri Revenue from the Internet services market;
Tr Total revenue from telecommunications services.
In this article, when calculating PENPON, we will, for practical reasons, disregard Internet
services for the following reasons:
Exact data pertaining to the Internet services market does not exist in the ITU
databases, therefore, it is impossible to determine a suitable weight factor and thereby
adequately valorize the service,
Development of the Internet services market for the observed period (1990-2001) is
almost imperceptible because more significant Internet development begins before the
end of observed period. Taking into consideration the total observed 11 year period,
we believe that the results of research conducted in this article using the indicator
given under (7) will be sufficiently representative.
Therefore, for practical reasons and as a measure of the total market development, this
the following formula will be used in this article:

n PEN n + m PEN m
PEN PON (7)
n + m

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Correlation between the development of telecommunications and
economic development
Generally speaking, in the period between 1991 and 2001, there was a relatively close
relationship between the degree of economic development and telecommunications
markets development, as well as between the degree of economic development and
telecommunications investments (see Table 2). The strength of the link observed through
time is of different intensity. On the basis of the analysis of the existence and intensity of
the link between telecommunications investments and GDPs in both groups of countries
it may be concluded that there is a relatively intense link between them.

Table 2: Determination coefficient results (r2) for the group of transition countries
between GDP per capital and markets of telecommunications services and between GDP
and telecommunication investments. Source: Research results.
Telecom.
Year PENn PENm PENi PENPON invest.
1991 0.12 0.00 0.00 0.27 0.40
1996 0.41 0.34 0.88 0.36 0.78
2001 0.50 0.86 0.92 0.76 0.92

Figure 1: Correlation between telecommunications investments and GDP in 2001.

Source: Research results.
1.400

1.200
y = 0,0192x - 100,24
Telecom investments (mil.USD)

R2 = 0,92
1.000

800

600

400

200

0
0 10.000 20.000 30.000 40.000 50.000 60.000 70.000
GDP (m il.USD)

Some other conclusions may also be drawn from the analysis of the correlation function
in the observed period In 1991, the correlation coefficient was at a level indicating a
weak dependence between telecommunications investments and GDP, which grows in
time and demonstrates a very high degree of correlation (r2=0.92) in 2001.
A weak interconnection may be interpreted as insufficient development of
telecommunications services in transition countries in 1991 (lack of critical masses)
which is necessary in order to gain benefits from network externalities.
The presence of network externalities indicates that the influences of the
telecommunications services market on economic development are not linear, meaning
that the effects are more significant when the development of the telecommunications
market has achieved a certain critical mass. This means that countries with a poorly

918
developed telecommunications would need to ensure adequate telecommunications
investments in order to be able to later achieve adequate economic and general social
benefits. Telecommunications and economic development could stimulate each other. On
one hand economically more developed countries may invest more in
telecommunications, while, on the other hand, these technologies may represent a
potential for future growth.
From the aforesaid it may be concluded that a certain degree of development of
telecommunications market is necessary in the beginning in order to obtain the effects of
connection with the economic development. It may also be seen there exists a certain
level of saturation when the link between these two variables stagnates, that is, weakens
with respect to the economic development.
Furthermore, we will analyze the correlation between the overall development of the
telecommunications market (weighted) and GDP per capita. It may be concluded from
the analysis that there exists a strong correlation (in 2001, r2 amounts to 0.76).
It can be concluded that in transition countries (which in average have mid-level GDP per
capita) the increase in GDP per capita results in the strengthening of connection between
the indicator of the overall development of the telecommunications market and GDP per
capita, which means that these countries are still in developing phase.

Figure 2: Correlation function (Telecom. investments GDP per capita) period 1991-
2001. Source: Research results.
1,00

0,90 0,92

0,80 0,78
0,70

0,60
r2

0,50

0,40 0,40
0,30

0,20

0,10

0,00
1991 1996 2001 years

Figure 3: Correlation between PENPON and GDP in 2001. Source: Research results.
80,0

70,0 y = 134,77x - 714,24

R2 = 0,7628
60,0

50,0
PENpon

40,0

30,0

20,0

10,0

0,0
0 2.000 4.000 6.000 8.000 10.000 12.000
GDP/capita

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Figure 4: Correlation function (PENPON GDP per capita) period 1991-2001. Source:
Research results.
0,90

0,80
0,76
0,70

0,60

0,50

r2
0,40
0,36
0,30
0,27
0,20

0,10

0,00
1991 1996 2001
Years

The decrease of the determination coefficient during the observed time frame between the
overall telecommunications market development and GDP per capita is the result, on one
hand, of the beginning of a phase of developmental saturation, which leads to weaker
interconnection between the telecommunication development and the degree of economic
development, while on the other hand, it is the result of the emergence of new
technologies, i.e. markets (e.g. mobile telecommunications and Internet) which begin
their (new) cycles of development and thus influence the general picture of
telecommunications development. These new developmental cycles will add up to
stronger links between these variables and economic development whereby the
determination coefficient increases in time (analyzing the total development).

Causality relations between telecommunications development and

economic development
On the basis of correlation analysis it was established that telecommunications
development and the degree of the economic development are interconnected, and that
there is a certain, in principle very strong link between them.
However, if we start a more in-depth analysis of the link between these two occurrences,
the question of does causality exist between them?" arises. One of the key issues in the
analysis of interrelationship between the development of the telecommunications market,
telecommunication investments and economic development is the establishment of their
mutual causality.
Are telecommunications investments a cause or a consequence of economic
development? Does the development of the telecommunications market cause economic
development or is opposite the case? Is causality present in both directions? Are there any
specific issues in transition countries with respect to West European countries, and what
might be concluded if we compare them?
The policy of advocating the stimulation of investments in the telecommunications sector
aimed at the development of the telecommunication market is often based on discussions
claiming that it is precisely those investments that, among other things, stimulate the
general economic development, which may be of special importance in transition
countries. In order to be able to firmly claim that the advocacy of such standpoints is

920
justified, it is necessary to empirically prove the causality of these two occurrences, since
otherwise there will be no sufficiently firm foundation to support of such viewpoints.
The Granger causality test will be conducted starting from 2001, for the period of 4
previous years, in order to be able to analyze whether the causality is delayed. In our
research, we used the Granger test like in Beil (2003) and Peguin-Feissole (1999). The
time series stationarity was ensured by taking into account differences of logarithms in
consecutive years.
The statistical procedure for confirmation of the causality hypothesis is the one about the
rejection of non-causality, that is, the rejection nul hypothesis (H0) which states that there
is no causality.
If we consider possible causality between these two occurrences on a theoretical level, it
is to be assumed that economic growth (the growth of national incomes per capita per
inhabitant) leads to a larger demand for telecommunications services which attracts other
telecommunications investments. Therefore, an increase in telecommunications
investments could be expected after a period of economic growth.
It is necessary to test causality in the reverse direction as well, since there are a series of
other indirect effects which appear as a result of a developed telecommunications market
(e.g. increased productivity) and also have an (indirect) influence on the increase of GDP.
Since modern developed economies need for their growth and development more and
more information transferred and processed via telecommunication systems, it is
expected that telecommunications will become an ever more important factor in the
economic development. To that effect, it could be expected that the development of the
telecommunication market would cause economic growth.
Test results of Granger causality are illustrated in Table 3. Notions YES or NO are
related to the rejection of the initial nul hypothesis Causality does not exist.
Therefore, in the event of YES, the nul hypothesis is rejected meaning that there is no
statistical evidence against existence of causality. If the answer in the table is NO, the
nul hypothesis is not rejected which therefore means that there is no causality.
We conducted the Granger analysis between GDP and investments, and vice versa as
well, for both groups of countries, with the most important results illustrated in Table 3.
In transition countries, statistical tests did not shown causality between GDP change and
telecommunications investments. This is, presumably, due to the fact that the
telecommunication markets of these countries did not have the opportunity to freely
develop during the observed period (regardless of the income increase) due to various
limitations in market development e.g. periods of exclusive monopolistic rights (in
Croatia, Croatian Telecom had exclusive rights and monopoly up to 2003), and because
in such monopolistic markets there was no interest to invest but to decrease the provision
of services below the level of market needs in order to maximize profit.
Conversely, having analyzed the causality between the change of telecommunications
investments and the change of GDP, the nul hypothesis on non-causality is rejected with
one and two years time lag (Table 3). This means that in the group of transition countries
telecommunications investments do influence the economic development (GDP).

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Table 3: Results of Granger causality for telecommunications investments and GDP and
vice versa. Level of significance: 10%. Source: Research results.
Time lag (years) 1 2 3 4
Transition BDP Telecominv NO NO NO ..
European
countries Tkinv GDP YES YES NO ..

Transition countries still have not entered the saturation phase in the development of
telecommunications services, and that the main task is to attract sufficient investment for
the development of a telecommunications market since the needs for telecommunications
services have been below the level of market demand for many years.
Apart from this, in the period in which we tested causality (1998-2001), the majority of
countries started privatization of national telecommunication operators whereby they
attracted additional investments and encouraged better productivity of these companies in
addition to better offer of telecommunications services.
Conversely, a relatively small absolute growth of national income in transition countries
was not sufficient to influence telecommunications investments, but other factors were
responsible for that, in the first place the average insufficient development of
telecommunications services with respect to the demand and the privatization of the
national operator and market liberalization which attracted considerable investments in
this sector.
Furthermore, on the basis of the analysis illustrated in Table 4 (Granger causality analysis
between PENPON and GDP per capita in the group of transition countries), it may be seen
that the hypothesis of non-causality may be rejected in both directions, but with different
time lags.
In the direction from GDP per capita PENPON, the nul hypothesis is rejected after a
two-year period, i.e. the economic development Granger causes a change in the
development of the overall telecommunications market after two years, while in the
opposite direction (PENPON GDP per capita) causality exists after three and four years.
It might be said that telecommunication investors, who mostly or almost entirely come
from the private sector, behave as rational investors, that is to say, they first observe the
development of the national economy and when wealth of the population increases, they
invest in the development of telecommunications services market.

Table 4: Result of Granger causality for the overall development of telecommunications

services (PENPON) and GDP per capita and vice versa. Level of significance: 10%.
Source: Research results.
Time lag (years) 1 2 3 4
GDP
per
capita PENPON NO YES NO NO

GDP
Transition per
countries PENPON capita NO NO YES YES

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The development of the telecommunications services markets follows the change of
national income which is the best way to satisfy market demand for telecommunications
services due to higher income.
In transition countries, the functioning of the telecommunications market has a causative
effect on the economic development because the development of the overall
telecommunication market is at an early stage of exponential growth, and the opening of
national economies and attracting other foreign investments resulted in the growth of
international trade (of economise that were isolated until then). The development of
telecommunications services has influenced the increase in the production of these
countries due to more trade, more efficient functioning of markets (due to faster and
better exchange of information e.g. prices or offers), lowering the cost of transactions
(e.g. quicker provision of financial services), lowering the cost of capital (as it makes
possible a greater efficiency in the functioning of financial markets), decrease of regional
gaps in incomes and productivity, positive effects of externalities etc.
As opposed to that, it is important to note that changes in the economic development of
transition countries cause changes in the development of the overall telecommunication
market after a two-year period.
The reasons for this are that developed telecommunication markets in West European
countries are sufficiently developed and are mostly in a saturation phase which results in
less investments since the market is already very well developed. On the other hand the
process of liberalization and privatization had been completed prior to the observed
period so that, from that point of view, there hadnt been any major investments in the
telecommunications sector.
The sole functioning of developed telecommunications markets in West European
countries and its direct and indirect influence on the economic development, as it may be
concluded from Granger statistical test, are not the only cause of economic development.

Conclusions
The telecommunications infrastructure with related services becomes a more significant
element of economic development especially in transition countries. Countries and the
economic sectors which have the necessary telecommunications infrastructure and
services are able to achieve post-industrial, information-based economic growth more
rapidly. Penetration ratio was used as an indicator of telecommunications development,
which is traditionally observed primarily through a prism of development of fixed
telecommunications services market (fixed telephony). In the last ten years, the
development of other telecommunications services, primarily mobile telecommunications
and Internet, has completely changed the image of the overall telecommunications market
development.
There is a strong correlation between telecommunications and economic development,
and between investments in telecommunications and economic development.
Granger causality was tested in both directions in the period of four years. The results of
Granger causality for telecommunications investments and GDP show the causality in the
direction from telecommunication investments towards GDP. This means that in East
European countries transition investments in telecommunications have influenced the

923
GDP. When observing causality of the overall development of telecommunications
markets and GDP in both directions, Granger causality is present after about three years.

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