The Internet’s Contribution to Progress and Growth in Germany

The Internet’s Contribution to Progress and Growth in Germany: The Economic Impact of the Internet and the Price Structure of Access

For a long time now, there has been intensive discussion in Germany, and other countries around the globe, amongst interested parties, about the need for “flat-rate” Internet pricing. Proponents of the provision of such a pricing scheme have argued that it is crucial to increasing use and access of the Internet, eliminating the “digital divide”, and, thus, to exploiting the full economic benefits the new technology brings. Although recognition of the benefits have lead to the introduction of flat-rate Internet pricing in many countries, in Germany lack of competition in the market for local telephony (in particu-lar, the monopoly position held by Deutsche Telekom and its imposition of metered charges on ISPs) has prevented it.

Therefore, the purpose of this paper is to analyse the need for flat-rate Internet pricing in the German economy, by answering two main questions: firstly, is increased diffusion of the Internet economically desirable; and secondly, if so, is the introduction of a flat-rate pricing structure the most effective way of achieving this? Parts 2 and 3 address the first question and part 4 the second.

In Part 2, about the effects of the Internet on efficiency and welfare, we find that the Internet makes the market, as a whole, more efficient and competitive and, thus, increases welfare. Characteristics of the Internet (immediate access and interactivity) reduce transactions costs between economic agents by easing communication between them and making them better informed about the market. As a result, the Internet transfers market power from the producer to the consumer leading to a new role of the consumer. The distribution channel is shortened, as consumers can deal directly with producers, causing “disintermediation” (the fall away of intermediaries). However, “re-intermediation” and the appearance of new intermediaries occurs in electronic markets, who add to transparency and reduce transactions costs further. The Internet allows a greater amount of outsourcing to be undertaken, encouraging firms to specialise on their core competencies, encouraging co-operation between firms and reducing the optimal size of the firm. In addition, reduced firm costs and global reach reduce barriers to entry. So that reduced transactions costs and barriers to entry increase competition.

In markets for “knowledge products”, which tend naturally to monopoly because of demand and supply-side economies-of-scale, we find that the Internet also generally increases efficiency and welfare. Whether knowledge markets “tip” in favour of monopoly depends upon the interplay of economies-of-scale and -scope. The Internet increases both. The result is that, in knowledge markets with “open standards”, where many firms compete within the market for producing system components, the Internet allows consumers to take advantage of increased “network effects”, as well as greater variety, thus, increasing welfare. In knowledge markets without accepted standards, and in which economies-of-scale are larger than demand for variety, the Internet may well encourage the market to tip in favour of one dominant firm. However, competition and innovation are strong and monopolies are only temporary: the minute a better product comes along the incumbent will lose their lead to the new competitor. Not only this, it would be welfare decreasing to restrict market share: firstly, consumers would lose out on network effects; and secondly, it would increase price (while traditional monopolists restrict supply to increase price, in markets for knowledge products a firm faced with demand- and supply-side economies-of-scale will increase output and reduce price in order to gain market share). On the whole then, the Internet increases efficiency and w elfare in traditional markets as well as in markets for knowledge products.

Part 3, on the effects of the Internet on the macro-economy, finds that the macro-economic gains derived from the Internet have been unevenly distributed between countries, largely due to differing levels of investment in, and therefore use of, in-formation and communication technology (ICT). The amazing macroeconomic performance of the US in the 1990s has lead economists to ask whether it is due to the diffusion of ICT. The so-called “New-Economy” theory says that increased competition brought about by ICT puts downward pressure on inflation, encourages innovation and increased productivity, and reduces wage demands, therefore, leading to higher contin-ued growth and lower unemployment. Empirical evidence shows that, despite the sin-gularly phenomenal macroeconomic performance of the United States during the 1990s, it has not been the only country to have benefited from the New Economy. A number of observations can be made in this regard:

Evidence shows that the Internet and ICT reduces inflationary pressures, both as a result of falling prices for ICT goods but also because of increased price competition in electronic markets. Numerous studies show that prices are lower when buying goods through the Internet and that other forms of price competition are also increasing.

Productivity increases in a large number of countries during the 1990s were due to large investment in ICT in one set of countries, while, in an other set, they were largely due to falls in employment associated with a move towards the employment of the relatively more highly skilled. The first set includes the US, Australia, Canada, and a number of European countries (Denmark, Norway, and Portugal). The second set includes the countries: Finland, Germany, Italy, and Sweden. In those countries where increases in labour productivity growth were associated with increased or stable employment and better investment in ICT, growth rates of GDP also generally increased. The few countries that benefited from increased MFP growth were also members of the first group, the exceptions being Finland and Sweden (which also gained but are members of the second group). The contribution of ICT-producing industries to output and productivity growth during the 1990s was generally lower in other countries compared to the US, the major exception being Finland, who’s contribution far exceeds that of the US. It should be noted however that more recent data indicate increasing contributions from ICT in most countries.

Increased “job matching” is said to increase job-market efficiency and, therefore, reduce unemployment. Structural change should lead to both job losses in less efficient sectors and job gains in new, more efficient, ones. Finally, increased demand for skilled labour should increase relative employment of the more highly skilled. The evidence shows that, although strong employment effects have been achieved in a few countries (Canada, Finland, the Netherlands, the United Kingdom, and United States)(also those who have invested heavily in ICT), in the majority this is not the case. Also, although, in the US, the supply of skilled labour has increased in response to increased demand, evidence of an increased wage gap between the relatively more highly skilled and the relatively less skilled shows that more investment in education is needed, even in the US.

In the case of Germany, rates of growth of GDP and Employment fell over the 1990s, productivity gains where mainly due to a relative move towards more skilled employment, and there was no apparent increase in MFP growth. A number of studies attribute poor macroeconomic performance in Germany to a lack of investment in ICT. It should also be noted that although Germany fairs well in terms of skilled labour, this is based on past investment: current student numbers are low in international comparison. Therefore, it can be seen that there is evidence of a New-Economy effect from ICT in a number of countries, not just the US. The New-Economy effect has, however, been unevenly distributed amongst industrialised countries. It is thus the case that, if it wants to share in the macroeconomic benefits from the New Economy, Germany has to invest more in ICT (i.e. the use of ICT should be encouraged). In addition, efforts should be made to increase the level of skills in the working population, by investing more in education and by encouraging use of foreign labour, where it can alleviate home market deficits (This refers to the “green card” issue for foreign specialists). Lastly, attention should be paid to providing the correct environment for businesses to expand into new areas of the ICT industries themselves. Otherwise, it faces the prospect of being left on the wrong side of the “digital divide”.

Part 4, involving an analysis of the factors influencing use of ICT, finds that there are significant differences in ICT penetration, between different individuals, households, and firms, due to socio-economic factors, as well as between different countries, due to differences in income and the availability of unmetered Internet access. At the level of the individual/household/firm we found that there are significant differences in ICT penetration dependent upon socio-economic factors (age, income, gender, education, and firm size) but that these differences are narrowing. The main factors preventing Internet access/use are financial. With regard to country differences, again those countries who were found to have invested in and benefited from ICT were also those who were the most “connected”. It was found in empirical studies that the main factors explaining this divide were income and the availability of unmetered Internet access (a flat rate)/ the amount of competition in the telecommunications market. Indeed, Haring et al. (2001) find that “…unmetered pricing for ISP and telecoms services increases access and usage demand by 31 and 35%, respectively, compared to regimes with usage sensitive ISP and telecoms charges.” It was also found that where unmetered Internet access was introduced it significantly increased both access to, and usage time of, the Internet.

As such we can conclude that if Germany wants to make the most of the numerous economic benefits brought about by the Internet it needs to encourage access to and use of the Internet. The most effective way to achieve this goal has been proven, on the basis of significant empirical and anecdotal evidence, to be the introduction of unmetered Internet access. Therefore, the dominant position of Deutsche Telekom in the market for local telephony and its refusal to allow ISPs to pay unmetered line rental charges is a significant barrier to gaining the wide spread economic benefits the Internet brings.

For in-depth analysis on this topic, see the article of the Hamburgisches Welt-Wirtschafts-Archiv (HWWA) on Deutsche Bank

The Internet’s Contribution to Progress and Growth in Germany: The Economic Impact of the Internet and the Price Structure of Access.