A matter of connections: OECD telecommunications sector productivity and the role of cellular technology diffusion

Information Economics and Policy 11 (1999) 243–269 www.elsevier.nl / locate / econbase

A matter of connections: OECD telecommunications sector productivity and the role of cellular technology diffusion Raghbendra Jha a , Sumit K. Majumdar b , * a

b

Indira Gandhi Institute of Development Research, Bombay 400 065, India Imperial College of Science, Technology and Medicine, The Management School, 53 Prince’ s Gate, London SW7 2 PG, UK Received 8 June 1998; accepted 20 May 1999

Abstract This article examines the impact of cellular technology diffusion on the competitiveness of the telecommunications sector for 23 OECD countries for the period 1980–1995. Cellular technology diffusion has proceeded rapidly in several OECD countries, providing substantial inter-connectivities with the fixed line telephone network, but there is substantial cross-sectional variation. Thus, consequences of cellular telephony on sector competitiveness, measured as relative productive efficiency, can be assessed. The results show that, controlling for a variety of other factors that can affect telecommunication sector productivity performance, cellular technology diffusion has a positive and significant impact on the competitiveness of the telecommunication sector. In addition, among the control items considered in our analysis, we find that liberalization of the competitive environment and privatizing the monopoly operator are factors positively enhancing productive efficiency. These are important findings highlighting the importance of micro-economic reforms in the telecommunications industry.  1999 Elsevier Science B.V. All rights reserved. Keywords: Competitiveness; Efficiency; Inter-connectivity; Market liberalization; Mobile telephony; Network externalities; Privatization

* Tel.: 1 44-171-594-9172; fax: 1 44-171-823-7685. E-mail address: [email protected] (S.K. Majumdar) 0167-6245 / 99 / $ – see front matter  1999 Elsevier Science B.V. All rights reserved. PII: S0167-6245( 99 )00017-7

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1. Introduction Subscriptions for mobile telephones have reached about 15% of the world’s current total number of telephone in an extremely short period of time. According to the International Telecommunications Union, almost half of the new subscriptions are now being made for mobile telephones. It is expected that by the start of the next century over a quarter of all of the world’s subscriptions, on average, will be for mobile telephony. Already in countries such as Finland the number of mobile phone connections now exceed the number of fixed line connections. Mobile telephone systems have been rapidly introduced because governments, in general, have been more willing to allow competition in this area relative to allowing competition in the area of fixed lines based services. Mobile telephone systems based on cellular technology have been technologically viable for over fifty years. Commercial viability, however, became feasible only in the early 1980s when the dramatic decline in computing cost made it possible to provide low cost necessary processing power. This led to the commencement of wide diffusion of the technology of mobile telephony, which then enabled communications connections to change both qualitatively and quantitatively. Quantitative changes arose in enhancing the number of physical interconnections. Qualitative changes arose in liberating customers from the tyranny of the fixed lines connection. Currently, calls to and from mobile telephone services start and finish primarily on fixed line networks. Thus, there is substantial inter-connectivity between alternative components of a network-based infrastructure. It is likely that in the not-too-distant future voice calls between mobile telephone systems will equal the number of calls between mobile telephone systems and fixed lines telephone networks. This will bring about a fusion of fixed lines based and mobile telephone networks, especially in countries that have a reasonable fixed lines infrastructure. Therefore, there is going to be significant blurring of boundaries between fixed lines and mobile operators. Additionally, most private conversations, as opposed to business conversations, will take place only using mobile telephones; nevertheless, the connecting link between the two mobile telephones will remain a fixed line link, especially where the two parties calling each other are some distance apart. Mobile telephony is one of the new more successful ways of communicating. Yet, in spite of the undoubted importance of mobile telephony in expanding collective connectivity, very little is empirically and theoretically known about the consequences of the diffusion of cellular technology or its impact on the competitiveness of the telecommunications systems as a whole. In other words, we may have a good sense of what it means in general to be connected, from a user’s point of view, and specifically in the telecommunications sector we may assume that an enhanced number of connections might be economically important. Nevertheless, we do not actually know, empirically, whether connections matter and what might be the consequences of expanding collective connectivity might be on the performance of the sector as a whole.

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Gabel and Kennet (1997) use simulation methodology to evaluate the cost structure of a typical fixed telephone network before and after the introduction of cellular service. They find that there may be potential efficiency gains for the existing fixed telecommunications infrastructure due to the widespread introduction of cellular technology. While their study is innovative, it is based on hypothetical data that are generated by simulation rather than actual data. Such data do not accurately reflect the complexities of reality. Additionally, there are no studies based on actual data that we have so far been able to locate. This is a lacuna, given the critical importance of mobile telephony within the overall telecommunications mosaic. We evaluate OECD data for the telecommunications sector of its member countries for the years 1980–1995 to explore a narrow empirical topic. We specifically evaluate the impact of cellular technology diffusion on the competitiveness of the telecommunications sector for OECD countries. Competitiveness is measured as productive efficiency, given the belief that for a country a productive telecommunications sector that is efficient in the use of resources is a competitive telecommunications sector. Our evaluation is based on a panel–data approach where we consider the data for 23 countries for the 16 time-periods – 1980–1995. During this period, of coverage of our study, reasonably rapid diffusion of cellular technology has taken place among several of the 23 countries. Yet there is wide cross-sectional variation between countries in the pattern of diffusion of cellular or mobile telephony at different points in time. Assessing the impact of this variation, then, provides important economic insights into the consequences of cellular technology diffusion on the competitiveness of the telecommunications sector. The article unfolds as follows. In the next section we describe the technical structure of mobile telephony systems and its relationship to the fixed lines telecommunications infrastructure. Thereafter, we describe the potential economic consequences of mobile telephony diffusion on this telecommunications infrastructure. In the section that follows we describe the methodology with which we empirically evaluate efficiency for the 23 countries over the 16-year period and provide details of the results obtained. We then discuss the implications of the results, while the final section concludes the paper.

2. Mobile telephony

2.1. Technical issues Mobile or cellular telephony involves the use of wireless facilities to obtain two-way communication between both parties using mobile telephones or where at least one of the parties uses a mobile telephone. Specifically, a mobile telephone system consists of base telephone systems (BTS), base station controllers (BSC) and mobile switching centers (MSC). BTS are transreceiver devices placed in the

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field to actually physically transfer a call to a customer’s handset, and there are as many BTS placed as there is need for coverage or capacity. A BTS may cover a region in area from 20 to 30 square miles, with the exact coverage area depending upon the specific technology being used. In congested cities, the BTS area of coverage can be much smaller. The base station controllers provide for the overall control and coordination of the switched signals. Each BSC can handle a multiple set of BTSs, and the BSC is responsible for the hand over operations of the calls between one cell and another, as well as for controlling the power signals between the BTSs and the MSCs. The mobile MSC is at the heart of cellular telephony operations. It is the primary switching interface between mobile telephone systems, and local exchange carriers and long-distance inter-exchange carriers. Local exchange carriers and longdistance inter-exchange carriers provide the fixed lines with which to deliver calls to their customers that are initiated by mobile telephone customers. Also, calls generated by fixed line telephone company customers are initially transmitted using the fixed lines infrastructure and then switched to mobile telephone customers. The present structure of tariffs is such that mobile telephone calls are more expensive than calls made using traditional fixed lines. For example, in 1992 mobile service tariffs were almost three and a half times higher than the tariffs to be paid for using fixed lines. As tariff rates fall, however, the use of mobile services is likely to be accelerated to the point where an equal number of calls are made using mobile telephone systems as are made using the fixed lines based systems. For example, in Israel, a country that is not falling within the purview of our study because it is not an OECD country, tariffs were set very low. Therefore, notwithstanding the small size of the country, which makes high cellular penetration relatively that much easier, diffusion levels of mobile telephony have been very high. A greater diffusion of mobile systems technology, relative to the development of fixed lines infrastructure for the purposes of voice communication, may be noticed even in countries that have a high penetration rate of the fixed lines infrastructure. Two notable recent examples of this phenomenon are Finland and Sweden. The growth in the usage of the Internet may, however, actually again trigger a demand for greater deployment of high capacity fixed lines infrastructure. As the three ways of providing a communications infrastructure – the fixed lines network, the mobile telephone network and the Internet backbone – interact with each other, enhancing the quantity and quality of connections that consumers might enjoy, the dynamic mechanism underlying the economics of industry evolution may change radically. We speculate on this issue in Section 5 of the article.

2.2. An assessment of diffusion trends Table 1 provides details of the diffusion of main telephone lines and cellular

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Table 1 Some statistical details for 1990 and 1995 for the countries studied a Country

Mainlines per 100 persons in 1990

Mainlines per 100 persons in 1995

Percentage of cellular subscribers to mainlines in 1990

Percentage of cellular subscribers to mainlines in 1995

Australia Austria Belgium Canada Denmark Finland France Germany Greece Ireland Italy Japan Luxembourg Netherlands New Zealand Norway Portugal Spain Sweden Switzerland Turkey United Kingdom United States

47.20 41.76 39.26 57.48 56.63 53.55 49.50 47.40 39.13 28.06 39.39 44.14 48.09 46.42 43.81 50.28 24.10 32.44 68.28 58.74 12.19 44.25 54.55

50.96 46.59 45.61 60.02 61.27 55.01 56.29 49.47 49.36 36.69 43.39 48.79 55.81 51.76 46.37 55.76 36.15 38.50 68.12 62.28 23.09 50.17 62.72

2.37 1.64 0.82 2.52 4.34 6.11 0.66 0.57 0.00 1.50 0.31 0.94 0.24 0.84 2.03 8.09 0.14 0.25 6.10 1.92 0.27 4.58 2.64

34.22 9.79 5.08 14.57 25.67 36.21 3.98 9.28 5.42 10.06 15.54 16.70 11.66 5.78 19.78 40.32 9.50 6.15 33.39 10.11 3.07 19.28 20.48

a

Source: OECD (1997) Telecommunications Database and authors’ calculations.

telephone lines for the year 1990 and 1995 for the 23 OECD countries that are studied. The cellular diffusion data provide the key variable of interest. The data for fixed lines penetration, however, is also of considerable interest. These data show an interesting pattern. In 1990, the average percentage of the number of cellular phones to mainline connections was 2.125, while the standard deviation was 2.246. By 1995, this percentage had increased to 15.92, with a standard deviation of 11.15. The growth in mobile telephones in the 5-year period is remarkable. Of course, since 1995 there has been even further growth in mobile telephony. The cross-sectional variation between the 23 countries is of considerable relevance. In 1995, Nordic countries such as Finland, Iceland, Norway and Sweden, and countries such as Australia and the United States have cellular to fixed line ratios of greater than 0.20, on a scale between 0 and 1. This can be due to the relative sparseness in the density of population in Nordic countries, coupled with relatively large fixed mass size in all of these countries, which makes cellular

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telephony an attractive option in providing communication facilities for the citizens. Countries such as France and Germany, which have a considerably large installed base of mainlines and a large land mass, but which according to the OECD are relative laggards in implementing telecommunications sector reforms, have considerably lower cellular diffusion ratios in 1995. It is also worth considering the relationship between policy reforms and the

Fig. 1. Rate of diffusion of mobile telephony in four policy-friendly and four not so policy-friendly countries.

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diffusion of mobile telephony. This is a very cursory evaluation; nevertheless, the evidence is telling. Eight countries are briefly evaluated. Four of these – Australia, Finland, New Zealand and the United States – are states that have carried out significant policy reforms to liberalize the telecommunications environment. Four of these – France, Germany, The Netherlands and Switzerland – are states that have lagged behind in telecommunications sector policy reforms. The classification is according to the OECD. In particular, up to 1995 the policy approach to telecommunications sector in France and Germany was characterized by a natural monopoly mind-set. In Australia, the analogue mobile telephony market was monopolistic, while the digital mobile telephony and paging segments were competitive. In Finland, the analogue mobile telephony, digital mobile telephony and paging segments were all duopolies. In New Zealand, the analogue mobile telephony, digital mobile telephony and paging segments were all competitive. In the United States, the analogue mobile telephony segment was a regionalized duopoly while the digital mobile telephony and paging segments were competitive. Comparatively, in France, Germany, The Netherlands and Switzerland the mobile segments were, at best, duopolies; and if these segments were not duopolies then they were monopolies. In these four countries, the fixed lines networks were monopolies, unlike the fixed lines networks sector in Australia, Finland, New Zealand and the United States which were, by and large, competitive. As Fig. 1 clearly shows, the rate of diffusion of mobile telephony is higher in the four policy-friendly countries – Australia, Finland, New Zealand and the United States – than it is in the four not so policy-friendly countries – France, Germany, The Netherlands and Switzerland. In 1995 the percentage of cellular connections to the number of fixed lines was approximately double in the policy friendly countries, as opposed to the percentage in the not so policy-friendly countries. We do not make a statistical test-based assertion; nevertheless, we observe that policy reforms do, prima-facie, seem to tend to speed-up mobile technology diffusion. Further detailed empirical research effort is certainly called for in this area so that issues of how changing incentives help new technologies diffuse can be evaluated.

3. Analysis

3.1. Estimation We use the diffusion data described in the earlier section to evaluate the productive efficiency impact of cellular technology on the telecommunications sector of the 23 countries, using a stochastic production frontier estimation approach. The model that we estimate is innovative in that it is a simultaneous one-step estimation of observation-specific efficiency parameters as well as the

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determinants of the cross-sectional and inter-temporal variations in these efficiency parameters. In prior work (Jha and Singh, 1994; Majumdar, 1997) we have used both non-parametric and parametric frontier approaches to obtain observation-level efficiency parameters. Thereafter, in separate second-step analyses the efficiency parameters have been regressed upon unit or firm-specific variables in an attempt to identify some of the reasons for differences in efficiencies between observations. This approach is extremely useful, but the estimation procedures are separate. The single-step estimation procedure, using a parametric framework, will lead to more efficient estimates. The stochastic frontier production function forms the basis of our estimation approach. This specification involves a production function specified for crosssectional data that has an error term with two components, one to account for random effects and another to account for observation-specific inefficiency. Typically, random effects estimation of the production or cost frontier is carried out, and then regressions of the residuals from this regression on the presumed determinants of efficiency are estimated. This approach, however, makes the implicit assumption that the error terms in the two steps of the model being estimated are independent of each other. If this is not the case, because the cross-equation error terms are correlated with each other, then the parameter estimates are likely to be inefficient though they are consistent. A single-step estimation that estimates both the frontier as well as the determinants of efficiency simultaneously is, therefore, superior and yields more efficient estimates.

3.2. Inputs and output variables For estimation purposes, data are drawn from the Telecommunications Database (OECD, 1997), published by the OECD and containing data for the period 1980–1995. A number of the variables are derived from the 1993 and 1997 volumes of the OECD Communications Outlook (OECD, 1993, 1997). The output variable ( y) chosen is total revenue of the operators (REVENUES) in US dollars and in constant 1995 exchange rates and prices. We have an output measure that is corrected both for exchange rate fluctuations as well as price level changes. Ideally, we would use the total number of call or the total number of minutes of calling as an output variable because using total revenues can confound for allocative efficiencies, given differing competition and regulatory policy regimes that prevail in the different countries. Unfortunately, we do not have data on total calls or total minutes of calling by country and over time. This is a lacuna. To obviate this lacuna, we introduce a number of control variables, such as the extent of liberalization of telecommunications markets, which help account for influences that may impact on the price component of our output variable. The two primary inputs chosen are: b1 , the number of total mainlines (MAINLINES) and b2 , total employees (EMPLOYEES); these are standard labor

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and capital inputs (Majumdar, 1997); b3 , time (TIME) is a secondary input because in an inter-temporal production time captures exogenous technical progress (Jha and Singh, 1994). In our translog specification, all these variables are expressed in their logarithms. The explanatory variables determining telecommunications sector efficiency between the countries include, d1 , the number of cellular subscribers (CELLULAR), as well as a number of controls. These control variables are important, and we describe them below.

3.3. Macro level control factors The control variables are as follows: d2 , time (TIME) is now included to capture inter-temporal performance. The impact of TIME may, however, not be crucial as an explanatory variable since a number of other control variables are time-variant. The variable, d3 , is investment per mainline (INVESTMENT ), expressed in US dollars and in constant 1995 exchange rates and prices, which controls for the effect of quality upgrades of the telecommunications infrastructure, and this variable is expected to positively relate to performance. The variable, d4 , is the total number of inhabitants in a country (POPULATION) and controls for scale effects at a national level. Several variables control for country level economic activity: d5 , gross domestic product per capita (GDP), in US dollars and in constant 1995 exchange rates and prices, controls for relative country economic performance. A higher value of this variable is expected to be positively related to performance, since relatively greater GDP signifies greater prosperity and, thus, a greater demand for telecommunications services. Such demand factors can augment calling volumes within a country, leading that country to display superior performance. A competitiveness measure such as ours captures the relative ability of each observation to expand output generation for the same or lesser consumption of inputs, with productive efficiency in resource utilization being an important measure of competitiveness and economic performance. Because our output is total revenues, the output parameter in this measure may increase due to exogenous circumstances. Simple economic growth within a country can lead to telecommunications output expanding in volume terms. As a result, the total revenue variable can increase in size and make a country-level observation appear efficient. The inclusion of the GDP variable helps to control for exogenous macro-economic factors that affect telecommunications sector revenues within a country. Similarly, the total revenue variable can increase because of exogenous factors causing a price rise for telecommunications services within a country. Such exogenous factors can, again, make an observation appear to look efficient. To control for one such exogenous factor, we introduce a variable, d6 , measuring inter-country price dispersion (TARIFFS). We use the inter-country data on the basket of business telephone charges, expressed in purchasing power parity terms,

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obtained from the 1997 OECD Communications Outlook, to capture relative variation between countries in telecommunications tariffs. This variable can be positively related to the efficiency variable since a country that charges higher prices for telecommunications services, relative to other countries, can enhance its telecommunications sector revenues. Such sectoral revenue enhancement can lead to a larger value being observed for our output variable.

3.4. Key institutional control factors We introduce a number of variables intended to control for critical institutional and industry-related factors that affect sectoral performance. The first of these is the extent of liberalization of the telecommunications market in each of the countries. The 1993 OECD Communications Outlook contains a detailed analysis of infrastructure competition in OECD countries. An index ranging in scale between 0, denoting the least liberalized environment, to 16, denoting the most liberalized environment, has been prepared by the OECD. This index is used to capture the extent of competition in the provision of telecommunications network infrastructure. Just a decade or a decade and a half ago the market structure in perhaps almost all of the OECD countries could be characterized by the presence of a monopoly. These were geographically divided monopolies as in Canada and Finland; functionally divided monopolies as in Italy; or privately owned monopolies as in Spain. Since then, especially after the 1984 AT&T divestiture in the United States, major efforts have been made to reform market structure. Among the OECD countries, in UK Mercury Communications was licensed to be a second operator in competition with British Telecommunications. New Zealand, thereafter, went the furthest and completely allowed open market competition. The OECD index, which is acknowledged to be a rough and ready measure of liberalization, nevertheless does afford insights that are in consonance with common perceptions. For example, according to the OECD, Germany in the period being studied was one of the least liberalized countries, while New Zealand, UK and USA were the most liberalized. Again, it is common perception that Scandinavian countries are, in general, liberalized. But the data do show intercountry variation even among the Nordic countries. For example, Sweden is the most liberalized Nordic country, with an OECD given score of 16, while Denmark and Finland score 1 and 8, respectively, for the period. These data are used to construct a variable, d7 – LIBERALIZATION, capturing the extent of telecommunications liberalization. The theoretical relationship between the liberalization index variable and competitiveness is straightforward. The more liberalized a country the competitiveness of its telecommunications sector is likely to be superior. There is now a large empirical literature on the liberalization and competitiveness relationship; for example, in the United States

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market liberalization over time has had positive productive efficiency consequences for the local operating companies. While the LIBERALIZATION variable gives an indication of general market structure reforms, specific conditions in the mobile telephony market also need to be accounted for. Over the period studied a number of countries have moved from monopoly structure or a duopoly, or even to a market structure with more than two players. We introduce a variable (CELLULAR OPERATOR) which is measured as the number of cellular operators in each country to account for this element of market structure. The OECD Communications Outlook provides details of the date of starting of cellular operations in each country, as well as the dates at which second and subsequent cellular operators, if any, have started up. These data give an indication of the competitiveness of the mobile telephony market in each country over time. The effect of the CELLULAR OPERATOR variable, d8 , on competitiveness is likely to be positive; but no strong a priori theoretical prediction is being made. The presence of fewer cellular operators can have an impact on price. If relatively high prices then exist, there is likely to be less of a consumption externality, as call volumes are not going to grow rapidly. With a greater number of cellular operators in the market, calling price-rates are going to fall relative to a situation where there is a monopoly. In general, volume will increase because of a price elasticity of demand effect. This volume rise may, however, not be adequate to offset falling prices and the total revenue impact need not be positive. There is a market expansion effect that takes place. Rising mobile call volumes trigger a dynamic network externality since such rising volumes lead to rises in the volume of fixed line calls. Such effects are, therefore, going to lead to growth in overall calling volumes and superior performance. Allied closely to the issue of market structure conditions in the telecommunications sector is the question of ownership. Most of the countries studied have telecommunications carriers that are owned by the State. Privatization, hence, has been one component of overall micro-economic reforms in the telecommunications sector. Privatization leads to a clarification of the role of the government in influencing sector performance, since the ownership and regulatory roles of the government are no longer overlapping and private ownership of erstwhile enterprises owned by the State is associated with positive efficiency implications. Based on the information that is contained in the OECD Communications Outlook volumes for 1993 and 1997, we denote the presence or absence of private operators’ presence in the industry by an index variable, d9 – PRIVATE. Canada, Spain and the United States have always had dominant private ownership of the main telecommunications operator. In UK the British Telecom privatization process commenced in 1984. In Japan, NTT was partially privatized in 1985; in New Zealand the primary operator was privatized in 1990 and in Denmark privatization was carried out in 1992. Up to 1995, discussions for privatization were being carried out in Germany, The Netherlands and Sweden. After 1995,

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which goes beyond the cut-off date of our analysis, France and Germany have each divested 20% of state ownership in France Telecom and Deutsche Telecom, respectively, while in the Netherlands 55% of state ownership in the operator has been divested. In all other countries, state ownership of the principal operator has been the norm, both for the period covered by our study and thereafter. There are smaller private operators, for example, providing mobile telephony services.

3.5. Infrastructure related control factors Two contemporary telecommunications infrastructure related variables have to be incorporated into our analysis. The variable, d10 , we now introduce is the number of Internet hosts (INTERNET ) in each country. Since the early 1990s there has been an explosive growth in the number of Internet hosts in OECD countries. In 1991 there were 566 952 hosts in these countries. By mid-1996 that number had increased to over 12 million. Among OECD countries too there is a great deal of variation in Internet host diffusion. In 1995 Finland led the OECD countries with 21.90 hosts per 1000 inhabitants, while, comparatively, France had 1.96 hosts and Turkey had 0.05 hosts per 1000 inhabitants. The difference is telling; particularly for France. Internet usage is one aspect of the development of telecommunications network infrastructure in OECD countries. In fact, the growth of the Internet creates interesting possibilities for industry dynamics to proceed in a particular way, since there are now three network-based infrastructures – fixed line telephony, mobile telephony, and the Internet – that has to be accounted for analytically. The impact of the Internet on overall telecommunications sector competitiveness can, however, be equivocal at the moment. On one hand, there is a major demand for second fixed lines, particularly in the United States. For local access providers, the ability to exploit economies of scope in providing second lines to the home has major efficiency consequences. On the other hand, the use of the Internet via existing phone lines does retard revenue growth in traditional voice telephony. This is because calling volumes for voice services are impaired when the Internet services are used, and, as yet, there are little externalities associated with Internet usage. Of course, as technologies change rapidly, changing the notion of inter-connectivities as we currently understand it, externalities are going to arise. A second issue relates to the standardization of cellular technology. Within a country, the existence of a particular standard for mobile telephony allows that telephone system to be interconnected to the fixed lines network. The withincountry competitiveness consequences of interconnection are, of course, going to be positive and significant as we have argued unless there is a wide variety of mobile technologies in use. Nevertheless, because of incompatibilities between analogue systems in use in different countries, the ability of the European

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networks as a whole to benefit in efficiency terms from the diffusion of mobile telephony is limited. In the OECD countries several analogue cellular technologies have been in use. In Australia, Canada, New Zealand and the United States, the American Mobile Phone System (AMPS) has been in use. Canada, Japan, Italy and the United Kingdom have utilized the Total Access Communications System (TACS). A third system in use, at 450 as well as at 900 MHz, has been the Nordic Mobile Telephone System (NMTS). This system has seen usage in Austria, Denmark, Finland, The Netherlands, Spain, Sweden and Switzerland. To obviate interconnection problems between incompatible systems, Europe as a whole has adopted the Global System for Mobile (GSM) as the digital technology standard to be implemented across countries. Moves are on to now change to the Universal Mobile Telephone System (UMTS) as the third generation mobile technology. The presence of GSM technology allows seamless interconnection between mobile telecommunications systems between countries. It is now possible for someone in Oslo to have a conversation with another person in Lisbon. The introduction of GSM technology has had an explosive impact on the diffusion of mobile telephony in Europe. For example, in 1995 there were just over 40 million subscribers in Europe. By the end of 1997 the number had reached 71 million subscribers, and by September 1998 subscribers had touched the 100 million mark. For the period covered by our study, however, only a few countries had introduced GSM technology. These countries were Denmark, Finland, Norway, Portugal and Sweden. To control for the impact of GSM technology, we introduce a dummy variable, d11 – GSM, which accounts for whether GSM technology has been introduced in any particular country for any of the years studied. We also introduce two variables, d12 and d13 , to account for interactions between cellular technology and our two key inputs.

4. Results

4.1. Basic findings In interpreting the results that are obtained it should be noted that a negative sign for a parameter estimate indicates that the variable has a positive impact on performance. In other words, an increase in efficiency is denoted with an increase in the value of a negative parameter estimate. Conversely, a positive sign that is obtained for a parameter indicates that the variable has a positive impact on inefficiency. In other words, an increase in inefficiency is denoted with an increase in the value of a positive parameter estimate. The results of the estimation are reported in Table 2. The upper panel (A) contains the estimates of the frontier production function, while the lower panel (B) records results of the determinants of inefficiency. The translog production

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Table 2 Regression estimates: production function and inefficiency (368 observations) Coefficient

Standard error

t-Ratio

Panel (A) b0 b1 b1 ? b1 b2 b2 ? b2 b3 b1 ? b2 b1 ? b3 b 2* b3 s2 g

19.582 2 1.771 0.066 1.813 2 0.116 0.167 0.052 2 0.002 2 0.011 0.047 0.951

1.753 0.564 0.061 0.523 0.066 0.070 0.125 0.011 0.010 0.004 0.028

11.17** 3.137** 1.094 3.465** 1.758* 2.371** 0.419 0.219 1.126 11.380** 33.823**

Panel (B) d0 d1 d2 d3 d4 d5 d6 d7 d8 d9 d10 d11 d12 d13 Log likelihood LR test of one-sided error

1.948 2 0.001 0.010 2 0.0005 2 0.001 2 0.037 2 0.032 2 0.011 2 0.013 2 0.095 0.0003 0.074 0.0002 2 0.0002 81.564 402.379

0.104 0.0006 0.007 0.0001 0.0008 0.003 0.005 0.005 0.013 0.044 0.0001 0.060 0.0001 0.0001

18.792** 2.339** 1.499* 3.976** 1.796* 12.815** 5.909** 2.218** 1.037 2.154** 2.597** 1.235 2.568** 2.629**

* Denotes significance at the 10% level, and ** denotes significance at the 5% level.

function has a satisfactory fit with the data that are being analyzed. The evidence of satisfactory fit is indicated by several factors. The value of the likelihood ratio is very high. Next, the likelihood ratio test of one-sided errors has a large value. Thereafter, chi-squared tests reject both simpler forms of the production frontier such as the Cobb–Douglas production function and the constant elasticity of substitution production function. The extent of cellular subscriptions (d1 ), investment per mainline (d3 ), the number of inhabitants (d4 ), GDP (d5 ), a presence of higher tariff rates (d6 ), the extent of market liberalization (d7 ), and the implementation of a policy allowing private participation in the telecommunications infrastructure (d9 ), are factors positively influencing telecommunications sector productive efficiency in the

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OECD countries. There is, however, diminished performance due to the spread of the Internet (d10 ). These are the significant findings from the econometric analysis.

4.2. Volume issues The positive effect of mobile telephony diffusion on fixed telecommunications systems’ efficiency, and thereby competitiveness, that we observe is construed as arising from a production network impact. Production impacts are of two types: pecuniary network externalities and technical network externalities (Capello, 1994). A pecuniary network externality implies that the costs of a network-based firm reduce with new firms joining the network because of a volume effect. A technical network externality affects the productivity of input usage in a networkbased firm because of the presence of network partners possessing higher quality inputs and a knowledge spillover effect from these partners. The mechanism as a consequence of which the volume and the knowledge spillover effect has a positive impact is a process of increasing returns to scale. The volume effect arises when there are increasing returns to scale involved in allowing mobile telephone systems access to the fixed lines infrastructure. In network industries, the sunk costs of an installed-base are very high. As the size of the overall physical network increases with the addition of mobile telephone interconnections, the marginal costs of operating the installed base of fixed lines gets progressively lower. With a larger network, and the greater volumes associated with size, the technological and administrative costs of operations can be spread over a larger installed base. This is an obvious static scale effect. The process of increasing returns propels a dynamic effect. It is fueled by consumption externalities. Consumption externalities exist when there is demand inter-dependence among customers; and, as Rohlfs (1974) has noted, the welfare of users is dependent upon other users in the network. The density and composition of customers in the network enhance this effect. The more dense and varied the network, the greater the value that an individual customer gains by being on that network. If there is high network density and variety, a customer’s ability to conduct more or varied transactions with the set of network customers is enhanced since there are more connections that can be made (Majumdar, 1998). Mobile telephone systems are, in many cases, a complementary technology to fixed lines systems and not a substitute technology, a fact particularly true in the developed countries. Though as diffusion of mobile telephony takes place the benefits to fixed lines customers are extended because of the presence of a number of mobile telephony customers, and vice versa. This implies that once investments in the fixed lines as well as in the mobile telephone infrastructures are made customers are likely to use the system more often, since there are greater communications opportunities due to an enhancement of network variety and density. Because of the consumption externalities that then occur, a process of increasing returns is engendered whereby the volume of calls grows at an

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increasing rate. Such growth in calling volumes, then, helps efficiently leverage the fixed lines infrastructure and leads to efficiency increases for the operators, because a progressively larger number of calls are available to write off costs over.

4.3. Technical issues The technical network externality affects the productivity of input usage in a network-based industry because of knowledge spillovers as well as a subsidiary imitative effect. This effect is noted when firms model their actions after firms perceived to be similar. Spillover and imitation arises because of inter-firm information flows that are induced where firms are inter-connected within an overall industry infrastructure. Such an effect is salient in industries where firms share a common infrastructure, such as railroads or telecommunications. In an environment where multiple technologies abound, it is difficult to keep track of all relevant knowledge that can affect general economic performance. Inter-firm networks, especially of the organizational variety involving human capital, provide a low cost conduit for accessing the relevant information. Because of inter-connectivity between mobile and fixed lines systems operators required for operational reasons, and the often though not always standardized nature of equipment and procedures used, several channels for the dissemination of experiences exist. Such information flows can help all firms or operators connected within a telecommunications network to capitalize on each other’s best practices and improve performance. Furthermore, with continuing diffusion the rise in inter-connectivities can trigger another process of increasing returns to scale. This, is the process of increasing returns in the inter-operator spread and use of information. Such a growth process in information flows help further enhances efficiency in input usage among the entities that are inter-connected to each other and their competitiveness.

4.4. Partial elasticities The effect of mobile telephony diffusion can be appreciated by reviewing data on partial elasticities. The partial elasticity statistic for cellular telephony reflects the percentage rise in sectoral efficiency that takes place for a percentage rise in the number of cellular connections, holding all other factors constant. In other words, the specific impact of cellular technology diffusion is measured. The partial elasticity data for the years 1990 and 1995 are charted for the four policy-friendly countries – Australia, Finland, New Zealand and the United States, as well as the four not so policy-friendly countries – France, Germany, The Netherlands and Switzerland. The graph is shown in Fig. 2. Fig. 2 shows that there has been an increase in the partial elasticity figure between 1990 and 1995 for all of the eight countries. This implies that an increase in cellular technology usage not only has a positive impact on sectoral per-

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Fig. 2. The partial elasticity data for 1990 and 1995 for the four policy-friendly and four not so policy-friendly countries.

formance, but this impact is getting larger over time. As cellular technology diffuses more, its impact on performance is seen to be increasing. Of course, the elasticity figures are considerably less than unity. That is perfectly understandable, since sectoral performance is affected by many other factors other than cellular technology diffusion. These factors we have controlled for. The key trend to be

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noted, however, is the rise in the partial elasticity values over time. This is an important result that we have generated, and its unequivocal implication is that a rise in connections does matter very much in enhancing sectoral competitiveness. What is also of interest, particularly to policy makers, is the inter-country variation in these partial elasticity values. Clearly, the United States has benefited the most because of cellular technology diffusion. It has a large landmass. It also has a large population. Therefore, the numbers of connections that can be made, and the network externalities associated with these connections, are very large. In 1995, the partial elasticity is 0.45; this implies that a 1% increase in the number of cellular telephones leads to a 0.45% improvement in sector performance as a whole. Comparatively, the other countries do not gain that much yet. Two of the not so policy-friendly countries – France and Germany – display partial elasticity values for 1995 similar to that of some of the policy-friendly countries – Australia and Finland – that we have studied. For 1995, the partial elasticity statistic for Finland is similar to that for France, while that for Australia is similar to that for Germany. Finland and Australia, while being relatively large in the size of landmass, are not heavily populated countries. Therefore, the extent of consumption externalities that can arise in Australia and Finland are considerably less than the externalities that can arise in France and Germany. Yet, by being policy-friendly states, Finland and Australia have encouraged cellular technology diffusion and both their telecommunications sectors have stood to gain. Clearly, Australia and Finland are recognized as having two of the most competitive sectors among the various OECD countries. The residents of these countries are reaping the benefits of policy-friendliness. France and Germany are countries where consumption externalities can be substantial, given the size of their populations as well as the size of the landmass. It is conceivable that if cellular technology had diffused to the same extent in France and Germany that it has diffused in Australia and Finland, then the impact on sectoral performance in these countries would have been very much more substantial. Therefore, to the extent that France and Germany have been laggards in implementing telecommunications sector reforms, the competitiveness of their telecommunications sectors, and the welfare of their citizens, have both suffered. Earlier we have argued that there is a dynamic process at play. As cellular technology diffusion increases, so does the density and composition of customers in the network as a whole. The more dense and varied the network, the greater the consumption externalities that are engendered and the greater the propelling of increasing returns. Therefore, it is reasonable to expect that the specific impact of cellular technology diffusion on sector performance will keep rising over time. Fig. 3 shows how the partial elasticity statistic for the United States has risen over the 10-year period between 1987 and 1995. This can be considered one indication of the dynamic process that is at play. It does pay to have a large number of connections.

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Fig. 3. Partial elasticity statistics for the US between 1987 and 1995.

4.5. The impact of liberalization So far we have discussed issues relating to the diffusion of mobile telephony, but in our analysis we have controlled for various other factors. We cannot report in detail the results for all of these control factors. Some factors do merit discussion. One of these is the extent of market liberalization and its impact on

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performance. We limit the discussion in this paragraph to market liberalization issues and to the eight countries we have hitherto referred to: Australia, Finland, New Zealand and the United States are the policy-friendly countries, and France, Germany, The Netherlands and Switzerland are the not so policy-friendly

Fig. 4. Partial elasticity values for 1995 for Australia, Finland, New Zealand, and the US (policyfriendly countries), and France, Germany, The Netherlands and Switzerland (not so policy-friendly).

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countries. Fig. 4 charts the partial elasticity values for 1995 for these eight countries. As is clearly visible from Fig. 4, the extent of market liberalization does have a discernible effect on sector competitiveness. Partial elasticity values for all of the four policy-friendly countries are clearly larger than the values for the four not so policy-friendly countries. In the case of Switzerland the statistic is zero since the

Fig. 5. The partial elasticity statistic with respect to the private participation variable for the year 1995, for the eight countries we are following.

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market is not liberalized for the period studied. The implications for the purposes of policy making are obvious, if sector competitiveness is to be enhanced.

4.6. The impact of private participation Another factor that merits discussion is the extent of private involvement and its impact on sector performance. Fig. 5 now charts the partial elasticity statistic with respect to the private participation variable for the year 1995, for the eight countries we are following. As is clearly visible from Fig. 5, the extent of private participation also has a clear and discernible effect on sector competitiveness. Partial elasticity values for all of the four policy-friendly countries, which incidentally have followed aggressive privatization policies if the sector was not already privately owned, as in the United States, are clearly larger than the values for the four not so policy-friendly countries. All of the not so policy-friendly countries – France, Germany, The Netherlands and Switzerland – have dominant state control of the telecommunications sector for the period studied. The implications of the evidence that we have generated for the purposes of policy making are, again, obvious. In fact, the partial elasticity values for the private participation variable are larger than the partial elasticity values for market liberalization. Policy reforms in the telecommunications sector should, therefore, have involvement of private participants as not just a major agenda item but a fundamental agenda item to be implemented without delay. The benefits for sector competitiveness are compelling.

5. Discussion of further issues

5.1. Implications for infrastructure deployment The results we obtain show that the diffusion of mobile telephony has a positive efficiency impact on the telecommunications infrastructure in OECD countries. Mobile telephones are expected to become ubiquitous as the standard means of communication for ordinary people (Cairncross, 1997). Therefore, these results have considerable implications for the deployment of both mobile telephony and fixed lines. In Sweden, the diffusion of fixed lines connections is actually taking place at a lower level than that of mobile telephones as a younger generation of users no longer perceive value in being connected to the fixed lines network. Similarly, in Japan the personal handy-phone system combines mobile and fixed lines telephony to give customers flexible communications. Within the home, the phone unit is a cordless unit using the fixed lines infrastructure. Outside the home the phone locks on to the beam from a local aerial and becomes a mobile telephone. Many similar examples in other countries are likely to be noted in the not-too-distant future, with

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consequences for the competitiveness of the telecommunications sector that are positive. In countries with existing advanced telecommunications infrastructures, such as the United Kingdom and the United States, as the local sector opens to competition the strategy of developing wireless loops to provide local services is being implemented. Because the wireless local loop system uses the airwaves to send the signals, as opposed to digging up roads to lay the communications links, it is intrinsically much cheaper to set up a wireless local loop. Wireless local loop costs are estimated to range between $250 and $500 per residential connection, while a fixed equivalent fixed lines connection is estimated to cost between $1800 and $2500. For basic voice connections, therefore, greater diffusion of mobile telephony services is perhaps likely to occur since the economics of construction favor such a process.

5.2. Technology and Internet-related issues So far we have discussed a scenario where there is considerable diffusion of mobile telephony, and the possible rate of such diffusion is greater than that of fixed lines. Congestion does occur on wireless networks because of the radio spectrum constraint. Technological developments within the mobile telephony field serve to release capacity constraints. While the availability of bandwidth is the primary limiting factor that slows down the diffusion of mobile telephony, the introduction of digital technology into mobile telephony provides a solution to the capacity problem. Mobile telephony has been based on time division multiple access (TDMA) technology. The introduction of code division multiple access (CDMA) technology, particularly in the United States, increases the bandwidth capacity usable by a factor of 10–20 times by allowing the use of the same frequencies. A CDMA channel at 1250 kHz can process 75 signals simultaneously. Conversely, in a 1250 kHz system, which is the basic size of a PCS channel, 42 signals can be carried as each analog signal uses 30 kHz of bandwidth. There is, however, a reuse factor of seven for analog. For every cell that is using one frequency, the surrounding six cells cannot use the same frequency. Therefore, the 42 signals have to be divided by six, yielding a figure of seven signals that are actually processed by a TDMA BTS for one frequency. The CDMA 75 signals to the TDMA seven signals ratio thus provides a ten-fold advantage if CDMA technology is to be used (McGarty, 1997). Within Europe, the digital technology standard set by an effective process of coordination is GSM. While the GSM technology is not as intrinsically powerful as the CDMA technology, it is still an improvement over the plethora of analogue technologies that have hitherto co-existed in Europe. The availability of highcapacity digital solutions in Europe and the United States provides a further impetus to the diffusion of mobile telephony. If mobile telephony incorporates the

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new technology, there are additional volume-based competitiveness implications for the fixed lines infrastructure since the new technologies permit almost a ten-fold capacity increase in channel usage. What impact such new technologies have on the interconnection pricing decisions of fixed line network operators is an issue we leave for future assessment. It is unlikely, however, that diffusion of mobile telephony services will occur at the cost of a complete halt in the growth of the fixed lines infrastructure. Using United States data, McGarty (1997) evaluates the feasibility of wireless personal communications systems (PCS) being used to provide an alternative to the local loop. While wireless local loop services may be economically feasible in certain niche areas, in large areas where the customer penetration density is less than 200 persons per square mile mobile or wireless telephony is not the most efficient means of providing local telephone services. Therefore, mobile or wireless telephony is not a clear application for the provision of universal services to all sections of a country’s population where a fixed lines infrastructure already exists. While construction economics and new technology availability spurs the diffusion of mobile telephony, the recent growth of the Internet simultaneously provides a new opportunity for expansion of the fixed lines infrastructure. Internet connections are made primarily through fixed telephone lines, and the growth of the Internet has boosted the demand for additional telephone lines in industrialized countries. For example, in 1996 Pacific Bell installed 700 000 telephone lines in California. Again in California over a quarter of all calls made using the fixed lines infrastructure in 1996 were Internet calls, and in the next 5 years Internet and voice calls are expected to be of equal proportion (Cairncross, 1997). The effect of explosive growth in Internet usage is to clog up the capacity of the fixed lines, especially at the last-stage connection to the home. This retards performance. While fiber optic cabling has made its presence felt in the inter-office and long-distance parts of the network, the last-stage home link is still, by and large, based on low capacity twisted-pair copper wires. While the final connection involving fiber to the home (FTTH) is expensive, with costs estimated at over $2000 per residential connection, the demand for additional fixed lines capacity is such that the diffusion of FTTH is no longer thought of as uneconomic, but instead as a necessity. Additionally, digital subscriber line (DSL) technologies, of which there are several variants, such as asymmetric digital subscriber line (ADSL) technology or high bit-rate digital subscriber line technology (HDSL), are an alternative way to expand the capacity of the copper wire that makes the final home connection. Both FTTH and the DSL technologies increase the capacity of the final link to handle volume by an extremely large order of magnitude. The diffusion of FTTH or DSL has the effect of improving the fixed lines infrastructure quality. As established for the US telecommunications industry, this impacts the productive efficiency of fixed lines operators (Majumdar, 1997). When the diffusion of higher quality fixed lines is linked to the growth of mobile telephony using new technologies, the productivity impact will be magnified because of two factors. The first is a growth in volume because of the extra

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capacity made available by FTTH as well as CDMA technology in the United States and GSM technology in Europe. Second, the introduction of Universal Mobile Telephone System (UMTS), which uses a higher bandwidth than that currently used, throughout Europe is on the cards. Third, there is an interaction effect between the new technologies because these technologies possess enhanced functionalities. Therefore, in sum, the simultaneous diffusion of mobile and fixed lines telephony has significant and positive productive efficiency consequences, and such a diffusion process can enhance consumption externalities as well. This is an issue worth further research effort.

5.3. The role of public policy The role of public policy then, also becomes important in influencing the growth of consumption externalities. In the United States, the Federal Communications Commission (FCC) had granted mobile telephone licenses to two suppliers in each market. These were the incumbent local company and another supplier. Since then, the FCC has authorized mobile telephony license holders to compete directly with providers of fixed line services rather than focus on the mobile telephony market. In major markets, the FCC has auctioned licenses to up to four different providers of PCS, thus allowing six mobile telephony suppliers within a market: two original cellular license holders and at least four PCS suppliers. The technologies used by the various players are not necessarily compatible. One public policy issue is the role of standard setting by a process of coordination for mobile technology. In Europe, the European Telecommunications Standards Institution has coordinated the spread and use of GSM technology. The post-1995 diffusion of GSM technology within Europe is a well-known phenomenon. Conversely, in the United States the mobile telephony standard is emerging through a market mechanism. In this process the best standard wins. While the level of diffusion of mobile telephony in the United States is high, it is nowhere nearly as high as the level of diffusion in say, Denmark, Finland or New Zealand. Yet, the evidence that we generate shows that the United States, among the OECD countries, gains the most in competitiveness terms through the diffusion of mobile telephony. The issue that then arise are: will the adoption of a coordination process to let a standard emerge in the United States lead to much further and wide-spread diffusion of mobile telephony? Will such an enhanced rate of diffusion lead to further efficiency benefits for the telecommunications sector in the United States? Or, is the market mechanism process to let a mobile telephony standard emerge truly the policy alternative of choice that is to be recommended? We leave these questions to be explored in future research.

5.4. Implications for developing countries The discussion has been anchored on analysis conducted for the OECD

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economies. For many developing countries where penetration rates of telephones are extremely low, the issue of catching-up with developed countries in terms of telecommunications infrastructure has meant investment in wireless or mobile systems local loops, bypassing investments in fixed lines completely. This has been the approach adopted in Eastern Europe, as they have built up their telecommunications infrastructures. Mobile links are a quick and inexpensive way of developing new telecommunications infrastructures from scratch, especially in countries where population is concentrated in a few centers. For example Ghana, the Republic of Tatarstan and Somalia are countries where new national telephone systems based on mobile telephony have been installed. In India the number of mobile telephony connections has crossed the one million mark in the shortest period ever since the introduction of mobile telephony. Where developing countries have a very low penetration rate of fixed lines, the issue of whether mobile telephony diffusion affects the competitiveness of the fixed infrastructure could be construed as irrelevant as there is not much of an installed-base lines to make an impact on. These countries, nevertheless, do need to invest in mobile telephony as well as develop their fixed lines infrastructure simultaneously. With Internet availability, the opportunities for a developing country’s citizens to acquire information cheaply and efficiently rises, raising awareness and giving citizens the potential to raise their living standards. By helping the spread of information in countries where educational facilities have been scarce, Internet diffusion can help developing countries leapfrog into the information age. Thus, in developing countries the simultaneous diffusion of mobile telephony and fixed lines telephony not only has direct productive efficiency consequences for the sector as a whole, but there are considerable human development implications connected with such diffusion processes.

6. Conclusion We study the impact of diffusion of mobile telephony on telecommunications sector competitiveness for 23 OECD countries. Whether there are significant economic benefits accruing to the existing installed-base of a given technology as a complementary technology spreads is important, since understanding what the economic consequences of diffusion of a new technology with network externalities is fundamentally important in contemporary research. The results show that cellular technology diffusion has a positive and significant impact on the efficiency of the telecommunication sector, thereby calling for further diffusion of mobile telephony. Concomitantly, recent Internet growth calls for further fixed lines diffusion, and the simultaneous diffusion of both types of telephony infrastructures can have significant overall consequences for sector competitiveness.

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