HOMEBLOGSRandom Thougts on Economics: Paul Romer & "Networked" Industries
09 November 2008

Random Thougts on Economics: Paul Romer & "Networked" Industries

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At the World Economic Forum meeting in Dubai, I had a very interesting discussion with Paul Romer (for those of you who are growth experts, yes, Paul is the father of Endogenous Growth Theory). We argued about whether governments in the developing world should intervene in “basic enabling networked” sectors like communications, infrastructures (especially roads and railroads), and electricity and power generation. His argument was that (a) these sectors are subject to “network externalities” (my benefit of using them depends on how many other people use them) and/or (b) these are sectors with large fixed costs so, if left to the arbitrariness of the market, private monopolies would arise… and we all know that private monopolies are as bad a public monopolies.

Most economists agree with the argument that, when market fails, governments should intervene. Even I am sympathetic to the argument that natural monopolies are bad for the economy. Adam Smith spoke of the evils of monopolies. Thomas Jefferson (who worked at the US patent office) said that, even though patents induce researchers to produce new ideas, patents were bad because they granted monopoly power to the inventor. So bad was the effect of monopolies on welfare that he decided that overall, patents were not a good idea.

But where I disagree with Paul (and with most other economists) is that I always see a large distance between the “textbook” government intervention and “actual” government intervention. The problem is that the governments that, according to the textbook theory, are supposed to intervene are “textbook” governments that do the right thing all the time. But, as the name itself indicates, these governments exist only in textbooks. In the real world (especially in the real developing world), governments are full of incompetent officials with the wrong incentives, work under the influence of pressure groups and lobbies, tend to be corrupt and have interests other than the welfare of the general public such as getting jobs for political affiliates, relatives or potential voters. This is true everywhere but countries in the developing world we tend to have fewer checks and balances on the government so the problem gets magnified.

This point is true in general but it is even more true (or more clearly seen) in the sectors that are being discussed. I could trust the management of the telecommunications industry to the textbook government (or perhaps the government of Norway or Finland)… but I am not sure I would trust it to the actual government of Kenya, Mexico or Laos. I remember growing up in a country where the telephone industry was a monopoly in the hands of the Spanish state, and I remember that it took months to get a single telephone line that went down every so often. Still today, the Spanish government supplies ONE SINGLE road to go from Barcelona to France. The road (called NII) goes through every town and has a traffic light every two kilometers. If it were not for private roads, all industries in Barcelona would be prevented from exporting to Europe.

If we look at the developing world we see lots of examples of private successes in these key sectors. Kenya, for example, used to have the telephone industry run by the government. And, as it was the case for Spain in the 1970s, it was a disaster: tens of thousands of employees doing nothing all day, telephone lines that took months or year to be installed, telephone wires that were continuously stolen, telephone connections that were down all the time. Then, all of the sudden, on the eve of the cellular revolution, the government opened up the sector to private competition and a number of companies were created. Some were foreign and brought technology with them. Today, the three largest operators in Kenya are Safaricom (the African name for Vodafone), Celtel and Telcom Kenya. The number of cell phones has increased from 7 million in 1999 to 80 million today. 80% of the Kenyan population is now covered by cellular networks (the percentage in countries like Uganda reaches 96%!). It is interesting to see the cellular network coverage map and compare it with the “lights” map we are used to see (remember that electricity is still supplied by the governments in many African countries). The map (provided below) shows that the cellular networks reach a lot more people and are a lot more generalized than electricity.

An important side point is that this communications industry is doing a lot of good, especially for the poor: it is enabling millions of entrepreneurs to discover new ways of doing business, it is allowing people to use cell phones as substitutes for banks to transfer money to remote areas, it is allowing farmers to gather instant information about the prices of the crops they sell which sends them to the best market in a matter of minutes, it allows for services (from repair men to tailors to doctors) to operate much more efficiently since they are now a phone call away from the customer. In other words, by allowing competition in the supply of one of these critical sectors, the government of Kenya has increased productivity manyfold. And this is good.

I agree with Paul Romer that these “networked industries” (roads, electricity, telecommunications(*)) are crucial sectors in the process of economic growth and development because they affect so many other industries (without electricity, private companies cannot produce textiles, food or radios, without communications, retail is very expensive, and so on). In fact, I agree so much that the corollary should be: “these sectors are so important that we should prevent the government from attempting to supply these goods”. Perhaps the key role of the government in these areas is to make sure competition exists as the private sectors supplies these products. If practical experience in these “key” sectors teach us anything is that real world governments are a far cry from textbook governments.

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Starting January 30, 2012, I decided to put the random (economic) thoughts that I was posting on Facebook, in a blog. In this site you will be able to read all Facebook notes going back to 2008, (without my Friend’s comments, unfortunately), but we will only maintain the new thoughts. If you want to check out the old comments, they are still posted on Facebook. If you want to comment on them, you have two options (1) Become a Facebook Subscriber. Since all the posts will also appear in Facebook, you will be able to comment there. (2) Comment on Twitter, as each post will also be announced in Twitter.