The Economic Impact of a Competitive Market for Broadband

Transcription

1 The Economic Impact of a Competitive Market for Broadband A cebr report for The Broadband Industry Group November 2003

2 This report is published by the Broadband Industry Group to raise awareness of the economic benefits that can accrue to the UK through a competitive wholesale broadband market. This report has been produced by cebr, an independent economics and business research consultancy established in 1993 providing forecasts and advice to City institutions, government departments, local authorities and numerous blue chip companies throughout Europe. The contributors to this report are Richard Greenwood, Sukhy Kullar, Douglas McWilliams, Mark Pragnell and Dominic Walley. Whilst every effort has been made to ensure the accuracy of the material in this report, the authors, cebr and the Broadband Industry Group will not be liable for any loss or damages incurred through the use of this report. London, November 2003

3 CONTENTS 1. Executive Summary Forecasting demand for broadband The impact of information and communications technology (ICT) on the economy How broadband affects the wider economy Broadband overview Adoption trends Business use of broadband Future broadband demand Demand forecasts Modelled demand Microeconomic Impacts Wider effects of broadband Estimating historic impacts Historic impacts and the ICT productivity debate Modelled productivity impacts Summary of other forecasts Comparison with other technologies Conclusions Macroeconomic impacts Methodology Results of the simulations... 26

4 1. EXECUTIVE SUMMARY Broadband will increase GDP by 22bn in 2015 This report represents the first attempt to quantify rigorously the benefits of broadband internet to the UK economy. It shows that by 2015 the productivity benefits of broadband could result in UK Gross Domestic Product (GDP) being up to 21.9 billion higher than it would otherwise have been. Broadband is revolutionary Broadband has the potential to revolutionise the way we live and work, delivering real economic benefits. We have established a link between broadband internet access and improved productivity and used this to examine the impacts of broadband on the wider UK economy. Currently 2.6 million broadband connections The number of broadband connections will see an almost fivefold increase by At present, over two million households and around 400,000 1 small and medium sized companies have a broadband connection. Our forecasts suggest that the number of households with a broadband connection could reach 10 million by 2010 with a competitive wholesale broadband market. This critical mass makes possible a wide range of new services and internet content. As more users are connected, so productivity improves Past evidence shows a clear link between communications technologies and economic growth. However, it is widely acknowledged that existing methods understate the growth benefits of the new economy 2. For this reason, we have chosen to model productivity using two approaches: cautious based on this past evidence and inclusive that takes account of the nature of the e-conomy. Improvements in productivity have wider economic benefits From the estimates of productivity gains, we report how changes in broadband connectivity affect the UK economy as a whole. We have also considered the direct implications for Government, consumers and businesses. 1 Figures for all businesses with one employee or more based on OFTEL s latest Business Use of Internet survey 2 See for example Affuso, L. and Waverman, L. (February 2002), The impact of electronic infrastructure on economic productivity and growth, London Business School Report for the Performance and Innovation Unit centre for economics and business research ltd,

5 Our analysis is based around three steps Adoption productivity macroeconomics Developing forecasts for broadband adoption by households and businesses Using data on the historic impact of communications technology to estimate productivity gains Modelling the wider economic impacts of increased productivity with the use of UKMOD, our UK macroeconomic model The estimated impact of broadband is similar to that of electricity We have also looked at historical comparisons, considering specifically two other General Purpose Technologies the railways and electrification. The comparison shows that our estimated impact of broadband is probably less than that of the railways but of about the same order of magnitude as electricity. Moreover, the development of broadband and hence its economic impacts is likely to have taken place very much more quickly than the other two technologies about three times as rapidly as the railways and about six times as rapidly as electricity Forecasting demand for broadband Demand model considers four main factors The first step in our process was to create a model of broadband adoption. Our analysis considered the following as the main explanatory factors: Price of broadband Quality of connection Size of the potential market Adoption curves for similar technologies (e.g. the internet, mobile phones) Figure A shows how we believe the broadband market will evolve until the end of the decade. These estimates may be conservative We believe that our forecasts are cautious, reflecting conservative assumptions for Personal Computer (PC) ownership growth and the future shape of the adoption curve. Our central forecast for demand includes continuous improvements in quality and reductions in price which are passed on to consumers through effective competition. centre for economics and business research ltd,

6 Figure A: Forecasts of household broadband adoption Households 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Period Household Broadband Connections Potential household market Source: cebr forecasts We estimate that household broadband subscriptions will be greater than 9 million by the end of These forecasts are similar to others in the public domain. Table B shows a comparison of forecasts. Table A: Comparison of broadband adoption forecasts Period cebr Analysys Enders Forrester Yankee Research 2004 Q4 4,416 3,844 4,242 n/a 4, Q4 6,076 5,123 5,790 n/a 5, Q4 7,371 6,207 7,202 n/a 6, Q4 8,389 7,062 8,415 n/a 7, Q4 9,141 n/a 9,537 8,962 n/a Sources: Europe s Broadband Focus Shifts to Profit, Forrester Research, June 2003; Broadbanders, Enders Analysis, September 2003; Business Data Services: growth opportunities and forecasts , Analysys, January 2003; cebr, November 2003 centre for economics and business research ltd,

7 1.2. The impact of information and communications technology (ICT) on the economy We have used existing evidence to explain how we expect increased broadband connectivity to affect productivity. UK specific broadband evidence is sparse Whilst there are no forecasts of which we are aware for broadband s future contribution to UK productivity, studies have been conducted which examine the impact of the broader category of ICT. Bank of England have estimated the link between ICT and productivity Our analysis draws on UK evidence from a Bank of England Working Paper by Nicholas Oulton. Oulton estimates ICT has added 0.6 per cent per annum to UK productivity growth over recent years 1. as has research on the US Data inadequacies in the UK have prevented estimation of the impact of communications on economic growth. However, there is fairly consistent evidence from the United States. Table B: Estimates of US communications led labour productivity growth US Total ICTcontribution to output growth Colecchia and Schreyer (2001) US Communications equipment contribution to output growth Communications proportion of ICT led growth % 0.08% 19% % 0.15% 17% Oliner and Sichel (2000) % 0.07% 12% % 0.15% 14% Jorgenson and Stiroh (2000) % 0.06% 20% % 0.11% 14% Average 16% Source: adapted from Affuso, L. and Waverman, L., The Impact of Electronic Infrastructure on Economic Growth And Productivity, February Oulton, op cit. Average of Oulton s estimates for ICT led productivity growth for High Software case and Low Software case for period from 1994 to centre for economics and business research ltd,

8 The basis for the cautious approach Our cautious approach is based on the evidence summarised above. We estimate that communications technologies have contributed one tenth of a percentage point per year to UK productivity growth in recent years. but this understates the true impact These estimates are likely to be significantly understated for two reasons. First, all of the studies used include a large residual element of productivity growth, reflecting an unexplained benefit from new ways of doing things. Broadband is a technology which will give rise to exactly this kind of unexplained growth. Second, all of the studies are based on an approach which splits growth into constituent elements which together add up to total productivity growth. Broadband is an enabling technology which makes certain other types of investment worthwhile. If a company invests in a broadband service, a new server and new software, then these studies would account for the productivity benefits by dividing it between these inputs. In practice, without the broadband connection, none of the other investment would have taken place. so we consider an inclusive approach as more likely Given that the previous estimates underestimate the benefits of broadband, we have modelled an alternate scenario, the inclusive approach. It is so called as it includes an estimate of broadband s contribution to residual growth and an estimate of other investment that would be foregone without prior broadband investment. The productivity impacts of the two respective approaches are shown in Figure B below. Figure B: Percentage increase in UK output per hour due to broadband 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% 2002 Q Q Q Q Q Q Q Q Q1 Cautious Assumptions Inclusive Assumptions Source: cebr forecasts centre for economics and business research ltd,

9 1.3. How broadband affects the wider economy Productivity improvements bring wider benefits If broadband delivers these estimated productivity improvements to individuals and businesses, then there will be wider economic benefits to the UK economy. There will be an impact on Gross Domestic Product (GDP), investment, consumer spending, and government borrowing. We have forecast the changes in these variables using UKMOD, cebr s model of the UK economy. which could add 22 billion to annual GDP by 2015 We estimate broadband to contribute between 5bn, under the cautious approach, and 22bn, on the more likely inclusive approach, to annual GDP by The main impacts are increased business investment and lower public borrowing as the economy performs better. Figure C: Annual impact of broadband on UK GDP (cautious and inclusive approaches), 2000 chained prices Impact on GDP ( millions) 25,000 20,000 15,000 10,000 5, Inclusive Cautious Our modelling suggests that, due to the growth in broadband connections, by 2015: Annual UK GDP could be up to 21.9bn per annum higher than it would otherwise have been (see Figure C above) Annual UK fixed investment will be around 8bn per annum higher than otherwise Annual government borrowing will be reduced by around 13bn per annum centre for economics and business research ltd,

10 Table B below shows a more complete set of results from the macroeconomic modelling. Table B: Economic impact of broadband ( million 2000 chained prices) Year Consumer spending Fixed investment Exports Imports GDP Cautious Assumptions , , , , , ,869.4 Inclusive Assumptions , , , , , , , , ,941.1 Source: cebr macroeconomic simulation using the cebr UK model UKMOD Nov Under both the cautious and inclusive approaches, broadband makes a large net contribution to UK annual GDP and boosts investment and consumer spending, with the investment effect the most significant. centre for economics and business research ltd,

11 2. BROADBAND OVERVIEW This chapter describes the current state of the UK broadband market. It examines recent trends in levels of connectivity, describes how businesses access the internet and summarises price levels in the residential market Adoption trends There are currently 2.6 million broadband subscribers in the UK, most of whom are residential users. Figure 2.1: Historic household internet and broadband access Households 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Q Q Q Q Q Q Q Q Q Q2 Period Households with a broadband connection Households with Access to the Internet Source: Constructed from ONS Internet Access (most recent 30 September 2003) and Internet Connectivity (most recent 19 August 2002) statistical releases Most new subscribers to broadband are households trading up from existing PSTN and ISDN connections. Digital Subscriber Line (DSL) technology has recently become the market leader in broadband as its availability has progressed while the growth in cable broadband availability has stalled. The diagram below shows historic broadband subscriptions by access technology. centre for economics and business research ltd,

12 Figure 2.2: Historic DSL and cable access Source: OFTEL Internet and Broadband Brief, July Business use of broadband Broadband offers a fast, cost effective internet solution for many small and medium sized businesses (SMEs). Larger businesses tend to use more expensive uncontended leased lines for fast, high quality, data transfer. However, they are often not a practical option for many SMEs due to the cost. Currently 65 per cent of SMEs have access to the internet. This proportion has remained stable over the last 18 months indicating market saturation at current price and service levels. New SME connections to broadband are likely to come from those upgrading from dial up connections and some downtrading from leased lines. Of SMEs that do have access to the internet, 25 per cent of small businesses (50 employees or fewer) and 31 per cent of medium sized businesses ( employees) connect using broadband 1. The diagram below shows how SMEs have connected to the internet since May Source: Business use of the internet: OFTEL small and medium business survey Q1 May 2003 (published 31 July 2003) centre for economics and business research ltd,

13 Figure 2.3: Access share of technologies amongst SMEs with internet access SMEs with internet access by connection type 80% 70% 60% 50% 40% 30% 20% 10% 0% 2001 Q Q Q Q Q2 Period PSTN ISDN Broadband Leased Line 2002 Q Q Q Q2 Source: OFTEL Business use of internet: OFTEL small and medium business survey, Q13 May 2003, (published 31 July 2002) The diagram shows that broadband is primarily taking access share from ISDN and PSTN dial up connections. However, small businesses dominate the data as small business make up 99.8 per cent of all SMEs (but only 48 per cent of employees). Of medium sized businesses, 19 per cent access the internet using leased lines and 36 per cent by ISDN and 31 per cent via broadband. centre for economics and business research ltd,

14 3. FUTURE BROADBAND DEMAND This chapter describes the modelling process that we have undertaken to estimate how broadband connectivity will grow over time. It summarises the forecasting approach and describes the key assumptions that represent our central adoption scenario. We have modelled broadband demand taking into account the impacts of price, quality (and speed) of service, the potential market size and market saturation. We have calibrated our forecasts with reference to adoption curves for other technologies. We have considered two markets for broadband, the residential market and the SME market, and have forecast demand for broadband in both accordingly Demand forecasts There are several forecasts for broadband adoption in the public domain. Our central case forecasts are consistent with these. Table 3.1: Comparison of broadband adoption forecasts Period cebr Analysys Enders Forrester Yankee Research 2004 Q4 4,416 3,844 4,242 n/a 4, Q4 6,076 5,123 5,790 n/a 5, Q4 7,371 6,207 7,202 n/a 6, Q4 8,389 7,062 8,415 n/a 7, Q4 9,141 n/a 9,537 8,962 n/a Sources: Europe s Broadband Focus Shifts to Profit, Forrester Research, June 2003; Broadbanders, Enders Analysis, September 2003; Business Data Services: growth opportunities and forecasts , Analysys, January 2003; cebr total broadband connections forecasts Compared to these other forecasts, we predict a slightly faster acceleration of broadband in 2005 and 2006 with slightly slower growth thereafter Modelled demand Our estimates of broadband s macroeconomic impact are based on demand forecasts and assumptions about prospective productivity gains. In order to investigate the economic impact of policy and pricing scenarios we have centre for economics and business research ltd,

15 developed a model of broadband adoption. We have modelled both the household and SME markets. The demand model is sensitive to: Price Quality (capturing both connection speed and customer service quality) Potential market size Market saturation The market saturation element of the model has been devised to allow us to calibrate broadband adoption to adoption curves for similar technologies (e.g. the internet, mobile phones). Our central forecast for demand includes continuous improvements in quality and reductions in price. The household and SME markets are individually constrained to a total market size. For households, this is given by households that own a PC and for which DSL or cable broadband is available. For SMEs, this is all SMEs with internet access that do not have a faster, leased line, connection. Pricing assumptions Both price and performance levels of ICT goods change quickly. It is therefore notoriously difficult to develop measures to accurately capture price changes for constant quality or performance of ICT goods or services. We have used the American Bureau of Economic Analysis price investment deflator for computers and peripheral equipment as an upper limit to cost savings available to the broadband industry. Historically this has shown computer and peripheral equipment prices falling by an average of 16.5per cent per annum between 1988 Q2 and 2003 Q2. We have assumed that: Wholesale providers pass on a 1 per cent price reduction per quarter to ISPs. ISPs make 2per cent cost savings per quarter on their own costs. By 2005 Q1 ISPs pass on all future cost savings. Quality assumptions We have used a generalised cost formulation to capture improvements in the speed of broadband and improvements in customer service. These are necessarily subjective, but are formulated so that (in conjunction with price changes) the cost per quality unit is consistent with not exceeding the price investment deflator. The assumption is that both wholesale providers and ISPs pass on a 1 per cent improvement in quality of DSL per quarter. centre for economics and business research ltd,

16 Together with the price assumptions, this implies that at its fastest, the quality adjusted price of broadband is modelled to fall by 1.8 per cent per quarter less than half of the historical rate of the Bureau of Economic Analysis price investment deflator for computers and peripheral equipment. Demand forecasts Our forecasts for household internet access are shown in Figure 3.1 below. These forecasts are based on conservative estimates of price and quality changes and the potential market size. Figure 3.1: Forecasts of household broadband adoption Households 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Q Q Q Q Q Q Q Q Q Q Q Q2 Period Household Broadband Connections Potential household market Source: cebr forecasts Our forecasts for SME demand are shown below. These are based on the same forecast changes in price and quality as the household market, but with a different modelling parameters (and, of course, a different potential market size). centre for economics and business research ltd,

17 Figure 3.2: Forecasts of SME broadband adoption 3,500,000 3,000,000 2,500,000 SMEs 2,000,000 1,500,000 1,000, , Q Q Q Q Q Q Q Q2 Period SME Broadband Connections 2008 Q Q Q Q2 Potential SME market Source: cebr forecasts We forecast that total broadband adoption will reach approximately 10 million subscriptions by the end of centre for economics and business research ltd,

18 4. MICROECONOMIC IMPACTS This chapter considers the evidence of how broadband is likely to impact upon productivity, based upon studies of similar types of technologies. The chapter features several approaches towards dealing with quantification of the impact of information and communications technology Wider effects of broadband The internet and data communications have transformed the way many businesses operate. Particularly for larger businesses, they have allowed quicker and cheaper access to customers and suppliers. In many areas costs have been dramatically reduced (a good example is internet banking), new products have been offered and efficiency has been improved as firms have reorganised the ways they operate. In individual industries, the internet has had a dramatic effect. Cisco for example claim to have reduced costs by US$650 million (5.3 per cent of revenue) 1 as a result of a series of internet related initiatives. It is asserted by Brookes and Wahhaj 2 that the internet could increase output of the manufacturing and extractive industries by as much as 5 per cent in the USA. Large companies that rely on fast data communications usually have high quality leased lines. These offer very fast uncontended data services at a very wide range of speeds comparable to broadband and up to speeds of 100Mbps and faster (around 100 times faster than a standard business broadband connection). Leased lines are comparatively expensive and have relatively long lead times to install, but nevertheless indicate that there is an existing technology which sets the upper limit on the extent to which broadband offers a new service. Broadband offers a second wave of fast data transfer benefits for smaller businesses and individuals for whom the cost of leased lines is prohibitive. It will allow them faster and cheaper data communications, enabling potential cost savings in a variety of new ways. There are applications in, for example, home working, health and home learning which could have substantial effects on costs and many others yet to be discovered. For households, digital broadband entertainment could provide true video on demand as well as music and information. Our analysis seeks to understand the potential size of these benefits for the UK by historical comparison. 1 See The impact of electronic infrastructure on economic growth and productivity, London Business School, February Brookes, M. and Wahhaj, Z. (2000), The shocking impact of B2B, Global Economic Papers, 37, February 3. New York, Goldman Sachs. centre for economics and business research ltd,

19 4.2. Estimating historic impacts Beyond individual case studies, there are few studies which attempt to quantify the clear evidence for the productivity benefits of the internet. Attempting to forecast the future impacts of a technology like broadband is even more difficult as many new applications have not even been conceived of at this point. However, there are many studies of the historical impact of information and communications technologies on productivity and economic growth. Information and communications technologies is a group that encompasses computer hardware, software, silicon chips and network infrastructure. The literature can be divided into: Aggregate impacts on productivity and growth Industry specific studies or case studies Studies focussing on the economy wide impacts tend to use growth accounting framework. These postulate a production possibility frontier that is dependent on a set of inputs. Equation 1: Potential Production = f (K 1, K 2, K 3 K n, L) Where K i = forms of capital inputs (e.g. IT hardware) L = Labour input Using this framework, growth is measured from the increase in inputs of various types. Any residual growth unaccounted for is considered to be improvements in methods and ways of working. This is called total factor productivity or TFP. Studies then measure: Contribution of ICT to GDP growth through the faster growth rate of the ICT sector Change in labour productivity due to more capital per worker of different types (capital deepening) Changes in total factor productivity Forward looking studies tend to either extrapolate from survey results of what people think the impact will be on them or their businesses (e.g. Fletcher Advisory Report) or imagine how broadband will impact in certain areas and attempt to quantify these individual impacts (e.g. the Brookings Institute Report). There have been many studies looking at the impact of the internet on different types of businesses. For example, Brookes and Wahhaj estimate that manufacturing output could rise by up to 5 per cent primarily due to lower input costs. Where savings are this large however, they are likely to centre for economics and business research ltd,

20 already have been made by large businesses through leased line connections. New approaches stress the role of ICT as enabling technologies that allow companies to improve their organisation and processes. These approaches question the wisdom of allocating growth to individual investments. Another new set of theories postulates a set of gains which are related to the level of adoption of a technology, that is, the more users, the more valuable a technology becomes Historic impacts and the ICT productivity debate ICT is generally considered to be a major source of economic growth. Most of the academic literature is from the USA and focuses on the higher levels of productivity growth seen in the USA during the second half of the last decade. Gordon (2000 and 2001) argues that the business cycle was responsible for this strong US growth, but this is disputed by the Council of Economic Advisors (2000). Rather, they argue, ICT spending has reduced the Non Accelerating Inflation Rate of Unemployment (NAIRU) by increasing labour market efficiency. The argument is that it is easier to match jobs to people and people to jobs with the informational possibilities created by the internet job market. Various US studies use growth accounting frameworks to investigate the impact of ICT investment on labour productivity. The table below summarises some of these studies. centre for economics and business research ltd,

21 Table 4.1 Estimates of US ICT led labour productivity growth US Total ICTcontribution to output growth Colecchia and Schreyer (2001) US Communications equipment contribution to output growth Communications proportion of ICT led growth % 0.08% 19% % 0.15% 17% Oliner and Sichel (2000) % 0.07% 12% % 0.15% 14% Jorgenson and Stiroh (2000) % 0.06% 20% % 0.11% 14% Average 16% Source: adapted from Affuso, L. and Waverman, L., The Impact of Electronic Infrastructure on Economic Growth And Productivity, February 2002 There is surprisingly little variation between these studies in the share of ICT led growth which can be attributed to Communications. Growth accounting methods allocate growth exclusively to one increased input or another. Therefore, they do not take account of investments in other capital that is enabled by communications advances, or the share of total factor productivity which is due to improved communications facilitating improved business processes. Any estimates based on this kind of growth accounting are therefore conservative in that they only take account of direct capital deepening. There is very little information on the impact of the internet from the point of view of growth accounting. This is partly a reflection of inadequate data on subdivisions of telecommunications investment and partly a reflection on the current inadequacy of the growth accounting methodologies to adequately capture enabling technologies such as the internet. Various EU and OECD studies show mixed results. ICT has contributed significantly to growth, but did not accelerate in the same way as in the US in the second half of the 1990s. Schreyer s (2000) initial study found little evidence of ICT affecting output growth in OECD countries. However, Gust & Marquez (2000) found that different labour productivity growth rates between can be explained by different levels of capital deepening (but similar levels of TFP growth). They argue that slower adoption of ICT is partially responsible for lower growth in capital per worker and thus weaker capital deepening. centre for economics and business research ltd,

22 Oulton 1 has studied the impact of ICT in the UK productivity. He estimates the impact of ICT on UK labour productivity based on two sets of assumptions. First, that the official measures of software investment are accurate and second, that these measures significantly underestimate software investment undertaken in house by companies. The two sets of outcomes under these assumptions are shown in Table 4.2 below. Table 4.2 Estimates of UK ICT led labour productivity growth Year Total ICT Contribution to growth Low Software High Software % 0.26% % 0.56% % 0.88% % 0.81% % 0.72% Average 0.55% 0.65% Source: Adapted from Oulton, N., ICT and productivity growth in the United Kingdom, Bank of England Working Paper 2001 Existing literature on the historic impacts of ICT and communications technologies shows a range of opinions over the magnitudes of effects and the appropriate methodologies to employ. We have therefore adopted two approaches. The first is a cautious approach based on Nicholas Oulton s work for the Bank of England which uses a growth accounting methodology. We have applied the proportion of communications proportion of ICT led growth US (16 per cent) to Oulton s figures and estimated that communications technologies were responsible for around 0.1 per cent of UK GDP growth over recent years. Our second approach includes some of the further benefits of communications technologies. This approach makes two further assumptions: Communications technologies allow us to work in new ways and are therefore responsible for a share of total factor productivity growth (equal to their calculated share of capital deepening growth) Communications technologies are enabling technologies, i.e. some other investment (for example in servers and other IT hardware) would not take place without investment in them. We have assumed that without communications technologies, 25 per cent of their ICT led capital deepening would not take place. This second approach yields an estimate of historic communications impact on GDP growth of 0.65 per cent per annum to GDP growth over recent years. 1 Source 1 Oulton, op cit. Average of Oulton s estimates for ICT led productivity growth for High Software case and Low Software case for period from 1994 to centre for economics and business research ltd,

23 4.4. Modelled productivity impacts We have used these two historic impacts to assess the future contribution that broadband could make to economic growth. Our methodology is to: Determine the future scale of communications spending Calculate broadband s share of communications spending Use this as a proxy for broadband s contribution to communications led growth The importance of communications to the economy is growing. We estimate that telecoms share of GDP is currently around 1.3 per cent 1. Based on historic trends, we estimate that this will reach 1.8 per cent in We have forecast communications spending to rise at its current rate until 2008 and to remain constant at 1.8 per cent of GDP thereafter. We have used broadband s share of total end user expenditure on communications as a proxy for broadband s share of this growth in the future. Total broadband spending is expected to grow from 7 per cent of communications spending now to close to 20 per cent by the end of our forecast period. Table 4.3 Forecasts of broadband s annual contribution to productivity growth Period Cautious Approach Inclusive Approach Q % 0.06% Q % 0.10% Q % 0.14% Q % 0.18% Q % 0.22% Source: cebr estimates This method is not perfect as it relies on spending as a proxy for broadband s importance as a communications technology. This implies that if the price of broadband changes, its economic contribution does not change directly with demand. However, it is the best measure available with which to form a base estimate Summary of other forecasts Various other commentators have forecast the impact of broadband on the economy. In this section we briefly review these forecasts. 1 Calculated from the Distributive Trades Survey Q which estimates nominal telecoms spend at 12.7bn centre for economics and business research ltd,

24 In July 2001, Fletcher Research argued that broadband would have a very dramatic impact on UK SMEs 1. They estimated that 40 per cent of SMEs would have broadband by This amounts to around 1.4 million businesses. The impact on these businesses would be to add 4.7 billion annually to their bottom line. This amounts to around 0.5 per cent of turnover (the turnover of companies with less than 100 employees was around 1 trillion in ). However, this could reflect shifting production from larger firms to SMEs this may not reflect a net addition to the economy. It is not clear how Fletcher Research reached these estimates of impacts on SMEs. In July 2001, the Brooking Institute 3 estimated that broadband could have an impact on GDP equal to up to 5 per cent of GDP. This was based on a bottom-up view of the likely benefits of different applications and a calculation based on consumer surplus Comparison with other technologies Economic historians have a technical term to describe technologies where the economic impact spreads widely into a large number of other sectors they are called general purpose technologies (GPTs) 4. From the descriptions given above, broadband clearly is a GPT. It is instructive to compare our estimates of the impact of broadband with other GPTs from history. We have therefore looked at two historical GPTs railways and electric power generation. The first interesting conclusion is that the economic impact of broadband is likely to come through much more quickly than those of both railways and electricity. Our forecasts indicate that much of the diffusion of broadband through households will have taken place within 10 years from the first applications. By comparison, after the first investments in railways in the early 1830s, the peak levels of railway investment in the UK did not take place until the late 1840s and significant investment was still taking place as late as the mid 1860s 5. With electricity the diffusion was even slower. Although electric power generation was invented in the early 1870s, as late as 1919 only 50 per cent of US manufacturing plants used electricity, though the figure rose to nearly 80 per cent by Fletcher Advisory, A Survey of the Impact of Broadband on SMEs in the UK, July DTI Small Business Service 3 Robert W. Crandall and Charles L. Jackson, The $500 Billion Opportunity: The Potential Economic Benefit of Widespread Diffusion of Broadband Internet Access, July The concept was introduced in Bresnahan, T., and M. Trajtenberg (1995) General Purpose Technologies: Engines of Growth, journal of Econometrics 65: B. R. Mitchell, The Coming of the Railway and United Kingdom Economic Growth in Railways in the Victorian Economy, M.C. Reed (ed) Paul A David and Gavin Wright General Purpose Technologies and Surges in Productivity: Historical Reflections on the Future of the ICT Revolution paper presented to the International Symposium on Economic Challenges of the 21 st Century in Historical Perspective, Oxford University centre for economics and business research ltd,

25 Estimating the quantitative impact of historical GPTs is complicated. But a widely accepted estimate of the social saving (a rather wider measure than productivity because it includes consumer surpluses) of the railways for the UK by 1865 is the wide range of per cent 1. The estimated impact of electricity differs between the US and the UK. For the US, there is little detectable boost to the growth of total factor productivity from 1870 to 1919 a period of 40 years. But then total factor productivity growth accelerated dramatically from 1.5 per cent per annum in to 5.1 per cent per annum from Although electrification was probably not the only driving force, it certainly made much of the additional productivity growth possible an impact over the whole of the 1920s of up to 41.7 per cent. In the UK there was a smaller acceleration in productivity growth around the same time. UK total factor productivity growth was 0.70 per cent per annum from compared with 0.45 per cent per annum for If all the additional productivity in the latter period resulted from electricity, the impact by 1937 was 3.3 per cent. These numbers compare with an estimated impact on productivity from broadband for the UK in this study that builds up to per cent in 2015 and per cent in 2028, depending on what assumption is made. The implication is that broadband could have an economic impact in the UK on potentially the same scale as electricity Conclusions Evidence from existing studies shows that communications technologies have increased labour productivity by around 0.1 per cent per annum in the UK over recent years. However, this only reflects growth from capital deepening essentially working in the same ways but having a larger supply of the communications input per person. This has formed the basis of our cautious approach. It is acknowledged, however, that these approaches may very significantly underestimate the effects of communications technologies. We have therefore developed an inclusive approach which, whilst more speculative, reflects the particular characteristics of the growth contribution of the new economy. These two approaches provide the link between historic productivity gains, potential future productivity gains and forecast wider impacts on the economy. 1 T. R. Gourvish, Mark Huish and the London and North Western Railway, 1972, pps 39 and David and Wright op cit 3 Matthews, R.C.O., C.H. Feinstein, and J.C. Odling-Smee (1982) British Economic Growth centre for economics and business research ltd,

26 5. MACROECONOMIC IMPACTS This chapter summarises how we have arrived at macroeconomic impacts from the changes to productivity. It provides detail of our UK economic model, the theory that underpins its functioning and results of the simulations we have run Methodology The approach used for this analysis is to translate the benefits of broadband into input for UKMOD, cebr s UK macroeconomic model, to understand the potential impact on the UK economy. Benefits of broadband The benefits of broadband are modelled as the difference between the economic forecast including the potential gains from broadband and a hypothetical base case where it is assumed that broadband does not exist. First the base case is constructed, based on cebr s latest forecasts and making an allowance for the hypothetical non-existence of broadband. Then the economic model is shocked to take account of the benefits of broadband. These are translated into three inputs: i) An increase in productivity using the two different assumptions about the impact of broadband on productivity based on the analysis in the earlier chapters. ii) iii) A reduction in the cost of internet connectivity as broadband cost savings are passed on to users, which implicitly reduces the cost of doing business and the cost of living; and An increase in business investment this is required to roll out broadband. Note that induced investment for example in the development of services - is endogenous in the model and therefore does not have to be inputted separately. UKMOD description The aim of the UKMOD model is to provide a high level macroeconomic environment to enable forecasts of the UK economy and what if simulations to be made. centre for economics and business research ltd,

27 Basic structure of the model UKMOD is based upon the familiar macroeconomic national accounting framework. It uses national data on System of National Accounts 1993 basis chain-linked annually to 2000 based prices. It is a general equilibrium model with separate sub-models for each of the key sectors in the economy. Overall consistency is achieved in the framework of the system of national accounts. Each sector is modelled on the basis of a set of behavioural equations, which are firmly based in economic theory. The dynamic processes of each equation over time are fully specified, using lags on endogenous and exogenous variables. UKMOD is modelled in chained volume terms, with price behaviour generated endogenously. Solution procedures The model is solved using standard spreadsheet packages. Level of sectoral disaggregation GDP and other main indicators are given for five sectors manufacturing, construction, energy, public services and other services. centre for economics and business research ltd,

28 The theoretical basis of the model Figure 5.1: Supply and demand structure of the model IN F L A T IO N POTENTIAL O U T P U T G D P INTEREST RATE The model has a demand and supply structure indicated in Figure 5.1. The demand side factors are: investment, consumption, public sector expenditure and trade. The supply side factors are capital, labour and resources. The balance between aggregate supply and demand in the economy determines the rate of inflation. The inflation rates in turn are used in UKMOD to model the interest rate which then feeds back into the supply and demand models. The demand side analysis is based around the identity: Equation 2: Where GDP = C + I + G + X M GDP = Gross Domestic Product C = Consumption I = Investment G = Government Spending X = Exports M = Imports centre for economics and business research ltd,

29 Model output The key indicators are: GDP (by sector), employment (by sector), unemployment, household incomes and consumer spending, savings, investment, exports, imports, the balance of payments, exchange rates, interest rates, public financial balances, public spending, tax receipts, corporate profits, borrowing and lending, inventory changes and prices. The key model equations are for consumption demand, investment, and a set of production functions, export and import equations Results of the simulations The impact of broadband The results of the simulations are summarised in Table 5.1. Table 5.1: Economic impact of broadband ( million 2000 chained prices) Year Consumer spending Fixed investment Exports Imports GDP Cautious Assumptions , , , , , ,869.4 Inclusive Assumptions , , , , , , , , ,941.1 Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept Under both sets of assumptions there is a growing boost to GDP from broadband, based on increases in consumer spending, investment and exports net of imports (which is a proxy for an improved supply side ). The boost from consumer spending initially results from the fact that the growth of broadband offers connectivity at a lower price and that this in turn reduces the cost of living and so boosts real disposable incomes. But over time the boost from higher consumer spending wears off because broadband boosts the supply side of the economy through higher investment and higher net exports and to some extent these crowd out consumer spending. Meanwhile, the benefits from higher productivity and an improved supply side and the impact of rising investment become the main drivers for additional GDP. centre for economics and business research ltd,

30 The major differences between the two analyses are in the scale of the effect on the more cautious assumptions the impact of broadband on GDP by 2015 is 0.5 per cent of GDP whereas on the more inclusive assumptions the impact is 2.5 per cent. Even the lower figure is a very large impact from a single technology. Looking at the impacts as they develop over time, Figure 5.2 shows the pattern of the impact on consumer spending. Initially (2006 to 2010) there is a benefit to consumer spending from the fact that broadband feeds through in a reduced cost of living. But over time the improvement in the supply side and the boost to demand from higher investment partly crowd out consumer spending and as a result much of the impact on consumer spending wears off. Figure 5.2: Impact of broadband on annual UK consumer spending ( million, 2000 chained prices) 5,000 Impact on Consumer Expenditure ( millions) 4,000 3,000 2,000 1, , Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept The pattern of the impact of broadband on fixed investment expenditure in the UK is different from that of the impact on consumer spending. Far from being front end loaded, this impact builds up over the years as can be seen in Figure 5.3. There is an initial early impact as with the development of broadband, investment in both equipment and services is brought forward. But after 2008 there are continuing gains to investment as the effect of broadband starts to spread through the economy. The impacts are twofold: direct impacts from the development of services and new applications; and indirect effects on investment more generally in the UK from a more productive and successful economy. centre for economics and business research ltd,

31 Figure 5.3: Impact of broadband on annual UK fixed investment ( million, 2000 chained prices) 10,000 Impact on Investment ( millions) 8,000 6,000 4,000 2, Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept Figure 5.4: Impact of broadband on annual UK net exports ( million, 2000 chained prices) Impact on Net Exports ( millions) 12,000 10,000 8,000 6,000 4,000 2, Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept The impact of broadband on the overall efficiency of the economy is best illustrated by Figure 5.4. This shows the effect on net exports (exports minus imports). As the economy is made more productive by the bringing forward of broadband development, the UK trading position is improved. Both exports are higher and imports lower net nearly half the total boost to GDP comes from this source by centre for economics and business research ltd,

32 Besides these effects there are some other impacts on GDP but they are relatively minor. The total impact on GDP can be seen in Figure 5.5 which shows how the benefits build up. Figure 5.5: Impact of broadband on annual UK GDP ( million, 2000 chained prices) 25,000 Impact on GDP ( millions) 20,000 15,000 10,000 5, Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept Figure 5.6: Impact of broadband on annual UK company profits ( million, 2000 chained prices) 1,200 1,000 Impact on Profits ( millions) Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept The impact of broadband on UK company profits is shown in Figure 5.6. There is an estimated initial gain of over 1 billion annually, but the modelled result is that competition subsequently bids this benefit down. In centre for economics and business research ltd,

33 real life this may or may not happen, depending on the structure of markets. If it does, however, it is representative of the fact that broadband is likely to improve the long-term efficiency of operation of the UK economy by making markets more competitive. Figure 5.7: Impact of broadband on annual UK public borrowing ( million) Impact on Government borrowing ( millions) 0-2,000-4,000-6,000-8,000-10,000-12,000-14, Inclusive Cautious Source: cebr macroeconomic simulation using the cebr UK model UKMOD Sept Broadband is also potentially good news for UK public borrowing as can be seen in Figure 5.7 it reduces the government s need to borrow ultimately by potentially up to 13 billion per annum. This reflects two factors : savings in public spending from higher productivity as a result of the use of broadband to help provide public services increased tax revenue from higher GDP (though the higher tax revenue is moderated by the fact that, with higher levels of investment, there will be higher levels of investment allowances). The improvement in public finances could enable tax rates to be cut, or could be spent on improved public services. Alternatively the benefits could be used to reduce the government s borrowing. In his Spring 2003 budget the Chancellor forecast that even as far away as 2007/2008 he would need to borrow 22 billion. This puts the potential benefit of up to 13 billion of broadband to the exchequer into perspective. centre for economics and business research ltd,

34 centre for economics and business research ltd, 2003 centre for economics and business research ltd Unit 1, 4 Bath Street, London EC1V 9DX t: f: e: cebr@cebr.com. w: 36