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Telecommunications

infrastructure investment
and economic
development

Francis J. Cronin, Edwin B. Parker, Elisabeth


K. Colleran and Mark A. Gold

A two-way causal relationship between One of the most difficult questions in exploring the relationship between
tebcommunications infrastructure in- telecommunications and economic development is determining a causal connec-
vestment and economic development, tion: While we observe that telecommunications development and general
eetabiished for the US economy in pre-
vkus anaiysis, Is tested at the more economic development often proceed together, is it telecommunications invest-
iocaiized state and sub-state level and ment that promotes economic development, or economic development that
for two specific sub-categories of teie- creates demand for more telecommunications services?’
communications infrastructure invest-
ment- central office equipment, and Researchers have investigated the relationship between telecommunica-
cable and wire. For time series of these tions investment and economic development for almost 30 years2
two sub-categoriee of teiecommunica-
tfons investment complied for the Com- Studies have found that highly developed national economies are
monwealth of Pennsylvania and two correlated with highly developed telecommunications infrastructure.
countries within Pennsylvania this However, it was only recently that statistical techniques sufficiently
analysis tests two causal hypotheses
consistent with the US national-level rigorous to disentangle the relationships began to be applied to these
analysis: First, the level of economic issues. The evolution of this research, employing state-of-the-art statis-
actlvity at any point in time is a reliable
tical techniques, has now confirmed at the national economic level the
pmdictor (‘cause’) of the amount of
telecommunications investment at a ia- existence of a feedback process in which telecommunications invest-
tef point In time. Second, the amount of ment enhances economic activity and growth, while economic activity
t&communfcations investment at any and growth stimulate demands for telecommunications infrastructure
poht in time is a reliable predictor
(‘cm~se’) of the level of economic activ- investment.3
ity at a later point in time. What has not been answered, prior to the present study, is whether or
not this interdependent relationship between economic activity and
Francis J. Cronin is Managing Director of
DRiIMcGraw-Hill, 24 Hartwell Avenue, telecommunications infrastructure investment at the national level also
Lexington, MA 02173, USA (Tel: + 1 617 holds at the state and sub-state levels - and if so, how it occurs. Does it
660 6424; fax: +1 617 660 6463). Edwin result from more highly developed economies needing, and being able
B. Parker is Presidentof Parker Telecom-
munications, PO Box 402, Gleneden to afford, more communications? Is telecommunications investment a
Beach, OR 97366, USA (Tel: +l 503 764 productive stimulus contributing to economic growth, or merely a
3056; fax: +l 503 764 3059). ElisahethK. consequence of that growth? Or is it both? Does the relationship
Colieran and Mark A. Gold are Senior
Associateswith DRI. between telecommunications investment and the economy vary be-
tween the national and state level, or between the state and sub-state
This study was originally performed by level? Does the relationship vary across sub-state areas (urban versus
DRYMcGraw-Hillin coniunctionwith Par-
ker Telecommunicationsfor a consortium rural, high-income versus low-income)? And finally, does the rela-
of Pennsylvaniatelephone companies. tionship between investment and telecommunications infrastructure

0306-5961/93/060415-l 6 0 1993 Butterworth-HeinemannLtd 415


Telecommunications infrastructure investment and economic development
vary by type of investment (eg central office equipment versus outside
plant)?
Statistical tests can empirically evaluate such questions. Often termed
‘causality’ tests, these analyses evaluate to what extent changes in one
variable relate to corresponding changes in a second variable. It is
important to note that statistical measures of causality can only be used
to accept (ie fail to reject) or reject the stated hypotheses. They provide
no measures of the magnitude of the causal relationship. For example,
causality tests themselves will not provide answers to such questions as:
How much additional economic activity can be generated by investing
an additional dollar in telecommunications?
This study goes beyond the previous research in this area in four
ways. First, we use information for the State of Pennsylvania to
investigate the causal relationship between economic activity and invest-
ment in telecommunications infrastructure at the state and sub-state
levels. Second, to capture the impacts of evolving technology and the
continuing restructuring of the economy, we use data through 1991, the
last year for which data are available. Third, to better understand the
potential for non-contemporaneous relationships, we examine how the
relationships between telecommunications investment and economic
activity vary over time - do changes in one factor immediately translate
into changes in the other, or do such changes take place over a longer
time horizon? Fourth, to determine whether different types of invest-
ment in telecommunications infrastructure result in varying causal
relationships, we conduct the analysis separately on investment data
categorized by central office equipment (COE) and cable and wire
‘Department of Commerce, ‘Comprehen- (outside plant). With this framework one can trace causal relationships
sive study of domestic telecommunications to specific segments of network equipment.
infrastructure: Notice of Inquiry’, Federal
Register, 9 January 1990, p 601.
*A. Jipp, ‘Wealth of nations and telephone
density’, Tel&wmmunications Journal,
Background studies
July 1963, pp 199-201; International Con-
sultative Committee on Telephone and
Summaries of three recent important studies investigating the rela-
Telegraph (CCllT), Economic Studies at tionship between telecommunications and economic growth are pre-
the National Level in the Field of Telecom- sented below. These studies represent the latest research in this area
munications, International Telecom- and cover international, national and sub-state applications.
munication Union. Geneva, 1966, 1976,
1976; E.L. Bebee and E.T.W. .Gilling,
‘Telecommunications and economic de- Hardy’s research
velopment: a model for planning and policy
making’, T&communications Journal, Au- Andrew Hardy conducted an analysis of data from 45 countries over the
gust 1976, pp 537443; P.D. Shapiro, interval 1960-73. Hardy considered the sequencing of relationships
‘Telecommunication and industrial de- between gross domestic product (GDP) and the number of telephones;
velopment’, IEEE Transactions on Com-
munications, March 1976; R.J. Saunders, he concluded that the evidence supported bi-directional causality - a
J.J. Warford and B. Wellenius, Telecom- change in the number of telephones caused economic growth and a
munications and Economic Development, change in economic growth caused a change in the number of
Johns Hopkins University Press, Balti-
more, MD, for the World Bank, 1963; ITLf- telephones.4 Using one-year time lags, Hardy found that telephones per
OECD, Telecommunications for Develop- capita in one time period were significantly related to GDP in later time
ment, Joint Report 2, 1963; ITU, Telecom- periods and vice versa.
munications and the National Economy,
1966. According to Hardy, his analysis demonstrates a potential dimi-
3F. Cronin, E. Parker, E. Colleran and M. nishing returns problem. The size of the effect of telecommunications
Gold, ‘Telecommunications infrastructure investment (measured by the number of telephones per capita) was
and economic growth: an analysis of
causality’, Tekommunications Policy, Vol inversely related to the prior level of telecommunications development.
15, No 6, December 1991, pp 52%535. In other words, the largest effect of telecommunications investment on
4A. Hardy, ‘The role of the telephone in GDP was found in the least-developed economies, and the smallest
economic development’, Tekommunica-
tions Policy, Vol5, No 4, December 1960, effect was found in the most-developed economies. This finding would
pp 27%266. suggest that, in the current analysis, we might expect the relationship

416 TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrastructure investment and economic development
between telecommunications investment and economic activity to vary
depending on the overall level of development found in the local
economy.

Previous DRI research


Previous DRI research applied sophisticated statistical techniques to
empirically determine causal relationships between economic develop-
ment and investment in telecommunications infrastructure at the
national level.5 The analysis revealed not only that increases in output
or GNP lead to increases in telecommunications investment, but the
converse is also true: increases in telecommunications investment
stimulate overall economic growth. This ‘causality’ was determined to
be significant in both directions. A review of the DRI national results
may be found in Cronin et aL6

The Parker and Hudson analysis


More recently, Parker and Hudson concluded a county-level analysis of
the relationship between telecommunications infrastructure and econo-
mic development for rural areas in Oregon and Washington states.7
They concluded that a correlation’ exists between telecommunications
infrastructure and rural economic performance. They had data for only
a single time period and hence were able to demonstrate simply an
association and not the causal direction of the relationship. Specifically,
more advanced telecommunications infrastructure such as single-party
service (relative to multiparty service) and modern digital switches
(relative to electromechanical switches) were positively correlated with
levels of economic performance in rural counties. These findings were
confirmed after statistically controlling for the effects of population
density. Less densely populated counties had both poorer telecom-
munications infrastructure and poorer economic performance. This
statistical control ruled out the possibility that the relationship was
merely an artefact of the relationship between each variable and
population density. Parker and Hudson recognize that these results are
strictly descriptive of conditions holding in the two specific states
covered by their study. They do, however, see in the DRI causality
analysis an explanation at the national level for the results they have
found at the county level in these specific rural areas.’

Objective of this study


%ronin et al, op tit, Ref 3. These previous studies all point to the economic effects of investment in
%rU, p 533. telecommunications infrastructure. DRI’s study and Hardy’s analysis
‘E. Parker and H. Hudson, Electronic By- also suggest that the impetus to telecommunications investment is
weys: State Policies for Rural Develop-
ment through Telecommunications, West- economic growth. The purpose of this current analysis is to determine
view Press, Boulder, CO, 1992. whether historical investment in the network at the state and sub-state
*Correlation analysis establishes the de- level for Pennsylvania has led to a statistically identifiable impact on the
gree of association between two events.
Causality tests determine whether one State of Pennsylvania and its local economies. Furthermore, the analysis
event causes or explains another event. seeks to determine whether economic development at the state and
‘Parker and Hudson.-.on cit. Ref 7...,DD164- sub-state level has caused the historical level of investment in the
181.
‘?he statistical procedure for confirmation telecommunications network, or if these decisions have been made
of such research hypotheses is one of independently of the local economic environment.
rejecting, as being statistically highly im-
The objective of this study is therefore to determine whether there is
probable, the opposite or so-called null
hypotheses which states that there is no statistical evidence to support either or both of the following
such relationship. hypotheses: lo

TELECOMMUNICATIONS POLICY August 1993 417


Telecommunications infrastructure investment and economic development

l Hypothesis 1: Changes in the level of economic activity in any time


period predict (‘cause’) changes in the amount of telecommunications
investment in a later time period.
l Hypothesis 2: Changes in the amount of telecommunications invest-
ment in any time period predict (‘cause’) changes in the level of
economic activity in a later time period.

Data

The establishment of causal relationships is a form of time series


analysis and, as such, several decades of historical data are required. In
order to conduct the analysis, measures of economic activity and
telecommunications investment in both the state and sub-state (county)
level are required. At the national level DRI’s analysis was conducted
using investment data developed by the US Department of Commerce,
Bureau of Economic Analysis. The BEA adjusts its series for factors
that may affect reported industry investment data. Such factors may
include changes in the tax law and regulatory rules. The use of
unadjusted accounting data in Pennsylvania introduces potential errors
in the data that may not have any underlying economic factors. Such
errors reduce the likelihood of observing a significant relationship. In
addition, any observed economic impacts at the state and sub-state
levels introduced by telecommunications infrastructure investment will
be significantly mitigated compared with national-level findings since
the former economies are significantly more open than the latter. That
is, the fact that the national economy is significantly less open (ie has
fewer linkages) allows it to capture a higher share of induced effects.
Therefore it would not be surprising for the robustness of the state
results to suffer compared to DRI’s national-level results, nor for
sub-state results to be less robust than state results.
For the state-level analysis we used an annual time series of Pennsyl-
vania total personal income as a measure of the performance of the state
economy. ‘i While gross state product would have been more compara-
ble with the prior research by Hardy and DRI, the three-year lag in
compiling the data by the BEA would have meant excluding from the
analysis post-1989 data. We believe this would have seriously dimi-
nished the information content and statistical validity of our analysis.
Furthermore, gross state product and personal income in Pennsylvania
exhibit a 94% correlation over the 1965-89 period. To control for the
effects of inflation, values are adjusted to 1977 constant dollars. As a
result of data limitations at the county level, total employment is used as
the best available indicator of economic activity.” On the positive side,
this will make our comparison with the Parker and Hudson findings
easier since their analysis also uses local employment as the measure of
economic performance. The data cover a 27-year time period from 1965
to 1991.
This analysis employs data on telecommunications investment activity
collected from the common carriers in Pennsylvania, both local ex-
“State-level personal income data were change carriers (LECs) and interexchange carriers (IXCs). Although
obtained from the US Department of Com- data were requested from all common carriers in the state, only 12 local
merce, Bureau of Economic Analysis
(BEA). exchange carriers and two interexchange responded with plant invest-
The employment series for Somerset ment data. Of the 12 LECs that responded, only seven provided data
and York Counties were developed from with the required level of detail over the necessary time interval. Still,
data obtained from the Pennsylvania De-
partment of Labor and Industry and from these seven LECs comprise over 96% of the state’s access lines. Specific
the BEA. time series have been constructed for net plant investment in central

418 TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrastructure investment and economic development

office equipment and in cable and wire. To control for inflation, values
have been adjusted to 1977 constant dollars.
At the county level, our original intent was to conduct the analyses on
data provided by LECs for a diverse set of many counties. This
approach would have allowed us to test whether the relationship
between economic activity and telecommunications investment varies,
based on a community’s characteristics (industrial composition, popula-
tion density, socioeconomic characteristics, etc). However, data limita-
tions stemming from the perpetual property records accounting system
maintained by most of the LECs prevented us from compiling sufficient-
ly long historical records of investment activity by local area. As a result
our analysis is limited to the information provided by GTE in York and
Somerset counties, for which decades of historical investment data for
the individual local exchanges are available. To control for inflation,
values have been adjusted to 1977 constant dollars.
Additionally, DRI’s sub-state analysis could not extend below the
county level as a result of the statistical requirements that a substantial
amount of history be available for each input to the tests. Data on
economic activity below the county level have not been compiled in a
consistent time series prior to 1988. For this reason, analysis at the
exchange level was not possible unless the exchange borders were
closely aligned with a county. A limited set of counties, including
Somerset and York, exhibited this characteristic. DRI’s sub-state
analysis focused on these counties.

Statistical background
13J. Geweke, ‘Inference and causality in Causality literature
economic time series models’, in Z. Gri-
liches and M.D. Intriligator, eds, Handbook The nature and estimation of causal relationships is covered extensively
of Economics, Vol- 2, North Holland- in economic literature.r3 A survey of broad philosophical issues and
Elsevier. Amsterdam. 1964, Ch 19. perspectives may be found in the Journal of Econometrics. l4 A subset of
“See, & A. Zellner; ‘Causality and caus-
al law in economics’, Journal of Eco- this literature, pioneered by Granger,” concerns the application of
nometrics. Vol 39. No l/2, Seotember/ certain forms of time series analysis to establish evidence of predictabil-
October 1966, pp 7-21; and-C.W:J. Gran- ity that would be consistent with causation. This avenue of thought has
ger, ‘Some recent developments in a con-
cept of causality’, Journalof Econometrics, developed through time and is effectively surveyed by Geweke.16 The
Vol 39, No l/2, September/October 1966, statistical procedures involved in applying ‘Grange? causality or similar
pp 19*212. tests now constitute a subject that appears regularly in applied eco-
I%. Granger, ‘Economic processes in-
volving feedback’, information and Con- nometrics textbooks.i7
trd, Vol 6, 1963, pp 2646; C. Granger, Specific mathematical specifications are required to depict the
‘Investigating causal relations by eco- assumed relationships between the phenomena being examined. Two
nometric models and cross spectral
methods’, Econometrica, July 1969, pp standard statistical tests have been judged appropriate for testing the
424436. direction of causality in small samples. These are the Granger test and
“Geweke, op cif, Ref 13. the Modified Sims test.18 Granger defines causality as: x causes y if, and
“See. for examole. E. Berndt. The frac-
tice of Econothethcs, Addison-Wesley, only if, y is better predicted by using the past history of x than by not
Reading, MA, 1991, Ch 6. doing so, with the past of y being used in either case. The Modified Sims
‘*For a detailed discussion of the prop- test is very similar to Granger’s. The Modified Sims test finds x causes y
erties of causality tests when used with
small samples, as in the present study, see if, and only if, a specification including earlier values of x and earlier,
Guilkey and Salemi. They conclude that current and future values of y is a better predictor of the time series of x
both the Granger and Modified Sims proc- than a specification including earlier values of x and earlier and current
edures provide accurate estimates with
smell samples. 0. Guilkey and M. Salemi, values of y (see the Appendix for a complete discussion of these
‘Small sample properties-of three tests for causality tests).
Granger-causal ordering in a bivariate Of course, we would prefer to specify the ‘true’ relationship. Since, in
stochastic system’, Review of Economics
and Statistics, November 1962, pp 666 general, we do not have such knowledge, we employ standard alterna-
660. tive specifications (ie Granger and Modified Sims). DRI employes the

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Telecommunications infrastructure investment and economic development

Granger test and the Modified Sims test because they are the standard
tests used in causality analysis and both possess acceptable small-sample
properties. It has been noted by researchers that these two tests, while
designed to examine the same phenomena, have slightly different
representations of the time sequencing of the relationships and, there-
fore, may generate similar or different results. In fact, when examining
a relationship between two variables, one test may indicate a causal
relationship during a given time frame or for a specific geographic area
while the other test does not; for a different time frame or geographic
area the latter test might indicate a causal relationship while the first test
does not. This does not invalidate the tests; rather it indicates that the
‘true’ relationship is more closely approximated by one test for a given
time interval or geographic area and by the second test for other time
intervals or areas.
We report results for both tests in order to increase the robustness of
our research. It is not necessary that both tests nor all lag structures
indicate a causal relationship - only that one of the tests and one of the
lag structures give test results greater than the critical value chosen.

Estimation issues
In conducting causality tests, it is important to address several estima-
tion issues that can have important implications for the results of the
analysis. First, it is important to determine the appropriate relationship
between the variables across time. For example, does a change in
investment in COE lead to a change in economic activity in the
following year, or does the effect show up two, three or four years later?
This time dimension is referred to as the lag structure of the variable.
(Should the test determine that COE is related to economic activity two
years later, economic activity is said to have a two-year lag structure.)
Statistical tests exist to determine the lag structure that should not be
considered in the analysis, based on possible biases in the behaviour of
the variables. I9 In the current study these tests indicate that at least a
two-year lag structure would be appropriate to remove any biases. Our
analysis uses two, three and four-year lag structures. While it is not
necessary to test more than one lag structure, the current analysis
includes these longer time frames to capture any latent impacts between
two variables that may take time to materialize.
‘% determine the appropriate lag struc- A second issue to be addressed in the estimation process is whether
ture, LaGrangian Multiplier tests can be the existence of trends in the variables will cloud the findings of the
run on the residuals of estimated autore- analysis. In other words, as both the level of economic activity and the
gressive processes for different variable
series. For a discussion of the LaGrangian level of telecommunications investment have increased over time it is
Multiplier (LM) test, see T.C. Mills, Time possible that this upward trend could mask the true relationship between
Series Techniques for Economists, Cam- the change in one variable and the related change in the other variable.
bridge University Press, Cambridge, UK,
1990, pp 147-l 50. DRI conducted statistical tests to determine whether trends in the
*% identify the presence of trends (unit variables exist, and the appropriate solution.*’ These tests uncovered
roots), the Dickey-Fuller test can be ap- evidence of trends in certain variables which were removed by using, for
plied. The Dickey-Fuller test applies data
to a specified autoregressive process to each year, the change in the variable from the previous year (referred to
ascertain whether a trend exists in the as the first difference of the variable) rather than the actual levels.
data; if a trend exists, the estimation of The technical specifications and tests used in the analyses are
parameters using ordinary least squares
will probably be biased. For more informa- described more fully in the Appendix.
tion on the Dickey-Fuller test, see D. Dick- Another important issue is the selection of the level of statistical
ey and W. Fuller, ‘Distribution of the esti- significance at which the hypothesis that telecommunications invest-
mator for autoregressive time series with a
unit root’, S&tis&a~ Association, 1979, pp ment causes economic growth can be satisfied. The causality tests are
427431. actually constructed to test the reverse hypothesis, ie that there is no

420 TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrastructure investment and economic development

Tabb 1. Themlatlonship behveencentral offke telecommunicationsplant investment and total


personal income in Pennsylvanta.

Granger test Modified Sims test


Two-yearlag F value (df = 2.22) F value (df = 1.20)
Income causes investment NS NS
Investment causes income 9.288 7.49b

‘99% confidence level; b95% confidence level; Three-yearlag F value (df = 3,20) F value (df = 1.19)
‘90% confidence level. ‘W stands for ‘degrees Income causes investment NS NS
of freedom’, a measure of the number of uncon- Investment causes income 6.4@ 6~35~
strained cases used in testing statistical signifi- Four-yearlag F value (df = 4,18) F value (df = 1 ,I 8)
cance. The ‘F value’ is the statistic used to Income causes investment NS 3.41=
measurethe significanceof the relationship.‘NS’ Investment causes inwme 4.18’ 4.15c
stands for not significant.

causal relationship between telecommunications investment and econo-


mic activity. This hypothesis is maintained unless the statistics reveal a
very high probability that it is not correct. We have chosen to report
results significant at levels ranging from the 0.01 to the 0.15 level. A
0.05 level indicates that the probability of getting a significant result
from a random sample, in the absence of a real effect in the population,
is less than 5%. In other words, the probability of accepting a finding
that ‘causality’ exists when, in fact, it does not is less than 5%.
Therefore the tests that confirm the existence of a causal relationship
can be accepted as reliable evidence of the importance of tele-
communications.21
Finally, statistical tests assume that the measured observations are a
random sample from an infinitely large population. They measure the
probability of observing a relationship that is significant in a randomly
selected sample of the population when no such relationship exists in the
population. In this case the tests were conservative, because the
measures are not truly a sample of a larger population, but are the
‘population’ of observations for the Pennsylvania economy for the
period 1965-91. The data describe the actual relationship in the
population, subject to measurement errors. Therefore the tests are
conservative and, when statistically significant, confirm a real effect in
the measured economy.

Findings
State level
This section discusses the relationships between two significant compo-
nents of telecommunications investment and economic activity at the
state level. The two investment variables are net investment in central
office equipment and net investment in cable and wire. Table 1 presents
the results of the analyses of investment in central office equipment.
As the table shows, for the two- and three-year lag periods we find no
significant effect of changes in total personal income in Pennsylvania on
central office equipment investment. One of the two tests (the Modified
Sims) shows a significant effect with a four-year lag period. This result is
“Since numerous factors (eg data report- consistent with the long investment planning cycles used in the telecom-
ing errors, definitional problems and speci-
fication errors) can affect the statistical munications industry for new central office equipment investment.
results - ie obscuring a relationship that in Installation and replacement of telephone switching equipment have
fact exists - we cannot ‘technically’ con- been more typically determined by multiyear investment budgeting
clude that no relationship exists, only that
we fail to reject the null hypothesis of no cycles than by quick response to market demands. Furthermore, the
relationship. longer time lag between economic activity and investment may reflect

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Table 2. The relationship between cable and wire telecommunicetionr plant investment and
total personal income In Pennsylvania.

Granger test Modtfled Sims test


Two-year lag F value (df = 2,22) F value (df = 120)
Income causes investment NS 4.93b
investment causes income NS NS
Three-yearlag F value (df = 3,20) F value (df = 1 ,I 9)
Income causes investment NS 4.54b
Investment causes income NS NS
Four-year/ag F value (df = 4,18) F value (df = 1,19)
Income causes investment NS E1.32~
Investment causes income NS NS
b95% confidence level.

both wider network considerations and the ‘lumpy’ nature of investment


activity.*’
Table 1 also shows that for all six tests the effects of central office
equipment investment on the Pennsylvania economy are statistically
significant at least at the 90% confidence level, and that four of these six
tests are significant at the 95% confidence level or better. The signifi-
cance of the relationship for each of the three-year lag structures is not
surprising. Theoretically, it takes time for telecommunications invest-
ment to influence the economy. The availability of newer, high-quality
telecommunication services through new switching equipment makes
productivity gains possible by businesses utilizing the new or improved
services. 23More productive businesses in other sectors of the Pennsylva-
nia economy in turn produce gains in real personal income. These
effects are strong: they appear in the shortest (two-year) lag structure as
well as in the longer-lag periods.
At the state level, statistical tests fail to determine that investment in
cable and wire causes economic growth. It is not clear why this is the
case, yet numerous factors (eg data reporting errors, definitional
problems and specification errors) can affect statistical results, obscur-
ing a relationship that may exist. As a result, it cannot be concluded that
no relationship exists simply because the test fails to find such a
relationship. However, with respect to the converse hypotheses, the
Modified Sims test indicates that changes in economic activity cause
changes in cable and wire activity (see Table 2). These results are
significant at the 95% confidence level for lags of two, three and four
years. The strongest results are recorded in year four, which would
support the expectation that it takes time for investment plans to be
developed in response to changes in the economic environment.

County level
The intent of the county-level analysis is to determine whether the
“8. Egan and L.D. Taylor, Capital Budget-
statistically significant causal relationship between telecommunications
ing for Technology Adoption in Telecom- investment and economic growth identified in previous studies at the
munications: The Case of Fiber, Center for national level, and in this study at the state level, can be observed at
Telecommunications and Information Stu-
dies, Research Working Paper Series,
more localized geographic locations. Additionally, if such relationships
Columbia Universitv, New York, April can be determined at the county level, it would be useful to explore
1989; comments by Lee M. Bauman,’ in potential differences in the impact of telecommunications development
‘Pacific Telesis - surviving and striving’,
Telephony, 9 September 1991, p 28.
on counties varying in size and industrial composition. However, the
=Ff. Cohen, The Economic impact of scope of the analyses is limited to the two counties - Somerset and York
Broadband Communications on the US - for which data could be collected for the appropriate time frame.
Economy and on US Competitiveness,
Economic Strategy Institute, Washington,
Somerset and York are the state’s seventh and ninth largest counties
DC, 1992. (respectively), based on a square mile measure. These counties differ in

TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrastructure investment and economic development

Tabla 3. Economic Eharact~Wka of York County.

1980 1985 lggo 1992


Total non-agricultural jobs (‘000) 138.4 139.6 155.8 153.2
Share of total (96):
Construction 4.3 4.9 5.5 4.7
Mining 0.3 0.3 0.2 0.2
Non-durable manufacturing 13.1 12.4 11.1 11.1
Durable manufacturing 29.2 24.2 20.4 19.9
Finance, insurance and real estate 2.4 2.9 3.0 3.2
Transport and utilities 5.8 4.9 4.9 5.1
Services 12.7 18.5 19.0 19.4
Trade 21 .o 23.7 26.1 26.9
Government 11.1 10.2 9.6 9.6
1992 figures are DRI estimates.
Resident population (‘000) 313.4 313.4 315.4 319.5
Source: US Department of Commerce, Bureau Per capita income ($900) 10.6 15.0 20.9 22.5
of Economic Analysis, and DRIIMcGraw-Hill.

characteristics across several dimensions. York is a relatively more


urban economy, with several large companies (including Caterpillar and
Harley Davidson); it is within commuting distance of Baltimore.
Somerset is a small, rural community in the Allegheny Mountains,
relying on tourism (skiing) and agriculture. York’s population is approx-
imately four times the size of Somerset’s. Tables 3-5 compare the
industrial composition of York and Somerset and the State of Pennsyl-
vania.
With respect to telecommunications characteristics, York County has
approximately 173 000 telephone access lines, 78% of which are re-
sidential. Nearly 84 000 (49%) of these residential lines have touch-tone
service; more than 28 000 (16%) have custom calling features. Of the
county’s more than 38 000 business access lines, nearly 89% are
equipped with touch-tone service, while only 3900 (10%) have custom
calling features installed. The county’s access lines are 98% digital.
Somerset has almost 38 000 access lines, 82% residential. Only 13 000
(34%) of these residential lines have touch-tone service and only 4000
(11%) have custom calling features. Approximately 72% of the county’s
6800 business lines are equipped with touch-tone services, while 12%
have custom calling features installed. One hundred per cent of the
county’s access lines are digital.
It is important to note that it is impossible to draw conclusive
cross-county comparisons on such a limited data set. Yet the results of
the county-level analysis are valuable because they are consistent with
the state-level findings and demonstrate that relationships between
telecommunications investment and economic development can be

Table 4. Economic charactwiatlcs of Somerset County.

IS60 1985 1990 l!BZ


Total non-agricultural jobs (‘000) 22.6 20.7 25.0 25.5
Share of total (%):
Construction 4.6 2.7 4.6 4.5
Mining 11.5 4.7 5.6 4.3
Nondurable manufacturing 10.3 12.1 9.9 10.2
Durable manufacturing 9.8 11.1 11.9 12.2
Finance, insurance and real estate 3.4 4.6 3.4 3.4
Transport and utilities 5.7 4.3 5.3 5.3
Services 17.7 21.9 22.8 23.3
Trade 19.1 19.9 21.5 21.8
1992 figures are DRI estimates. Government 18.0 18.3 15.0 15.0
Source: US Department of Commerce, Bureau Resident population (‘GJO) 81.2 80.3 79.4 82.3
of Economic Analysis, and DRVMcGraw-Hill. Per capita income ($‘OOO) 8.5 10.4 14.0 14.4

TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrastructure investment and economic development

Table 5. Economic characteristks ot the Commonwealth ot Pennsylvania.

1999 1996 1996 1992


Total non-agricultural jobs (‘000) 4 753.0 4 729.9 5 170.4 5 033.6
Share of total (%):
Construction 4.0 4.0 4.4 3.9
Mining 1.0 0.6 0.5 0.5
Non-durable manufacturing 10.6 9.7 8.5 8.5
Durable manufacturing 17.1 13.3 11.2 10.5
Finance, insurance and real estate 5.0 5.6 5.8 6.0
Transportation and utilities 5.5 5.1 5.1 5.2
Services 20.5 24.7 27.9 29.0
Trade 20.6 22.6 22.8 22.7
1992 figures are DRI estimates. Government 15.2 14.4 13.7 13.8

Source: US Department of Commerce, Bureau Resident population (‘000) 11 862.2 11 777.0 11 905.5 12 050.1
of Economic Analysis, and DRINcGraw-Hill. Per capita income ($900) 9.9 13.6 18.7 19.6

statistically observed for smaller geographic areas despite the much


greater dissipation of these impacts due to the more open local
economies.
We find statistical relationships in York County that are not identifi-
able in Somerset. Perhaps this is not surprising, given the difference in
size, industrial composition and telecommunications infrastructure be-
tween the two counties. The results for York County are presented in
Tables 6 and 7 below.
Table 6 shows that the Modified Sims test, but not the Granger test,
finds a statistically significant relationship between investment in COE
in York County and economic growth using all three lag structures. The
longer lag structures of three and four years reveal more robust results
(at the 90% confidence level) since it takes time for the effects of
telecommunications investment to feed through the economy.
Consistent with the state-level results, we find statistical evidence to
suggest that a significant causal relationship exists between economic
activity and COE investment in York County. In fact, when using the
Granger test to examine the relationship between a change in economic
activity and investment in COE four years later a statistically significant
relationship is found (at the 90% level). Once again, this result is
consistent with the long investment planning cycles used in the telecom-
munications industry for new central office equipment investment and
the probability that wider network considerations may affect carriers’
investment decisions for a specific county.
The results of the analysis of the relationship between outside plant
telecommunications investment and total employment in York County
differ substantially from the state-level results (see Table 7). While we
find no evidence of a relationship at the state level, the Modified Sims

Table 6. The relatlonshlp between central office te4ecommunkatlons plant lnveetment and total
employment In York County

Granger test Modlfled Sims test


Two-year lag F value (df = 2,21) F value (df = 1,19)
Employment causes investment NS NS
Investment causes employment NS 2.76’
Three-year lag F value (df = 3,19) F value (df = 1,18)
Employment causes investment NS NS
Investment causes employment NS 3.41c

Four-year lag F value (df = 4,17) F value (df = 1,17)


Employment causes investment 2.34’
Investment causes employment NS
‘90% confidence level: ‘65% confidence level.

424 TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrmtructure investment and economic development

Tabb 7. nw fowonship between out8lde plant teiecommunicntlons Investment and total


employment in York County

Oranger test Modifbd Sims test


Tweyear lag F value (df = 2.21) F value (df = 1,19)
Employment causes investment NS NS
investment causes employment NS 3.2P
Three-yearlag F value (df = 3,19) F value (df = 1,18)
Employment causes investment NS NS
Investment causes employment NS 3.94=
Four-year/ag F value (df = 4.17) F value (df = 1,17)
Employment causes investment NS NS
Investment causes employment NS 3.49c
=909/o confidence level.

test, but not the Granger test, indicates that the conclusion that
investment in outside plant causes economic activity can be accepted at
the 90% confidence level. The causal relationship of economic growth
to investment in outside plant is not detected at the county level, even
though the Modified Sims test demonstrates such a relationship at the
state level.
The statistical tests for Somerset County for both COE (see Table 8)
and outside plant (see Table 9) fail to detect significant relationships in
either direction for all lag structures of COE and for the two- and
three-year lag structures for outside plant investment. However, for the
four-year lag structure the Granger test finds that investment in outside
plant causes economic activity at the 90% confidence level. This finding
concerning the causal relationship of outside plant to economic growth
in Somerset County provides some support for the results in York
County.
The positive impacts of central office equipment on employment in
York County and outside plant investment on employment in both York
and Somerset Counties are particularly important findings. These
results are consistent with the significant negative correlation between
unemployment and telecommunications infrastructure found by Parker
and Hudson in rural counties in Oregon and Washington. The Parker
and Hudson findings were comtemporaneous and therefore could not,
by themselves, indicate causal direction. The York County data pre-
sented here show that investment in both central office equipment and
outside plant causes changes in employment activity for the three lag
structures tested, while the Somerset County analysis finds that invest-
ment in outside plant causes economic growth.
The finding of a significant result for outside plant investment in both
counties, but not in the state as a whole, is consistent with a finding of
the 1980 Hardy study that the greatest economic benefits were obtained

Table 8. The relationship between central oftioe tekommunloationa plant Investment and total
employment in Somerset County.

Grange test Modtfted Sims ta8t


Two-year fag F value (df = 2,21) F value (df = 1,19)
Employment causes investment NS NS
Investment causes employment NS NS
Three-yearleg F value (df = 3,19) F value (df = 1,19)
Employment causes investment NS NS
Investment causes employment NS NS
Four-yearkg F value (df = 4,17) F value (df = 1,17)
Employment causes investment NS NS
Investment causes employment NS NS

TELECOMMUNICATIONS POLICY August 1993 425


Telecommunications infrastructure investment and economic development

Tabk 9. Tha ralatkxnahlp bahvaan outside office talacommunlcationa invaatmant and total
employment in %meraat County.

Grangar teat Modified Sims teat


Two-yearlag F value (df = 2,21) F value (df = 1 ,19)
Employment causes investment NS NS
Investment causes employment NS NS
Three-year lag F value (df = 3,19) F value (df = 1,18)
Employment causes investment NS NS
Investment causes employment NS NS
Four-yearlag F value (df = 4,17) F value (df = 1,17)
Employment causes investment NS NS
Investment causes employment 2.7T NS
‘90% confidence level.

in the locations with less-developed pre-existing infrastructure. The


findings from the current analyses suggest employing telecommunica-
tions infrastructure investment as a means to stimulate local economic
development.
The county-level findings that investment in both COE (in York) and
outside plant (in both York and Somerset) is related to economic
activity are particularly important because they indicate that small
geographic areas can be affected by such investment activity. Furth-
ermore, the fact that county-level employment is the indicator of
economic activity in this analysis provides additional insights concerning
the extent of the impact of telecommunications investment. Previous
analysis by DRI has demonstrated that investment in telecommunica-
tions infrastructure affects the productivity of other industries.24 The
current analysis, however, was able to find evidence of a causal
relationship between growth in telecommunications investment and
growth in local employment, demonstrating that the efficiency gains
generated by telecommunications investment do not outweigh the
economic expansion resulting from this investment.

Summary and conclusions


Our findings at both the state and county level support the conclusion
that telecommunications investment affects economic activity and that
economic activity can affect telecommunications investment. These
findings are consistent with national-level results. The county-level
findings are particularly significant because they indicate that even
relatively small geographic areas can be affected by investment in
telecommunications infrastructure. These findings are summarized in
Tables 10 and 11.
Our analysis supports the conclusion that investment in COE by the
common carriers at the state level is related to such measures of
economic activity as personal income. This finding is confirmed using
24F. Cronin, M. Gold and S. Lewitzky, two statistical tests. Additionally, the results indicate that the impact on
‘Telecommunications technology, sectoral personal income from investment in COE is evident two, three and four
prices and international competitiveness’,
T&communications Policy, Vol 16, No 7, years after the initial investment. The results of the analysis also provide
September/October 1992, pp 553-564. support for the conclusion that a change in state economic activity leads

Table 10. Doaa telacommunicationa invaatmant laad to economic actlvlty?

Hypothesis State level County level


York Somerset
Investment in central office equipment causes economic activity Yes Yes -
Investment in cable and wire causes economic activity _ Yes Yes
‘Yes’ indicates that a relationship exists.

426 TELECOMMUNICATIONS POLICY August 1993


Telecommunication infrastructure investment and economic development

Tabla 11. Doaa aconomlc advtty lead to telecommunicatlona investment?

Hypothesis state level county level


York Somerset
Economic activity causes investment in central office equipment Yes Yes -
Economic actMty causes investment in cable and wire Yes - -
‘Yes’ indicates that a relationship exists.

to a corresponding change in investment in COE. A statistically


significant relationship, however, appears for one test only in the fourth
year after the change in economic activity. These results would there-
fore indicate that changes in economic activity take longer to affect
investment in COE than changes in COE take to affect economic
activity. These findings are not unexpected, however, given the long
investment cycle and wider network considerations affecting the capital
expenditure decisions of the common carriers.
One statistical test indicates that economic activity causes cable and
wire investment at the state level. In fact, it can be concluded that a
change in economic activity affects investment in cable and wire two,
three and four years later. The findings reveal the strongest relationship
between a change in economic activity and the change in investment in
cable and wire four years later. This finding also supports the expecta-
tion that it takes time for infrastructure investment plans to be de-
veloped in response to changes in the economic environment, but that
investment in cable and wire appears to respond more quickly to
economic changes than do investments in COE.
At the state level, the analysis fails to support the conclusion that
investment in cable and wire causes economic growth. It is not clear why
this is the case, so it cannot be concluded that no relationship exists
simply because the tests fail to find such a relationship. Some support
for the supposition that cable and wire is important for economic growth
is found at the county level and is discussed below.
The COE analysis for York County yields results almost identical to
the state-level analysis. Results for one test indicate that a change in
investment in COE in York County is related to changes in economic
growth in the following two, three and four years. There is also less
evidence to suggest that a significant causal relationship exists between
economic activity and central office equipment investment in York
County. When testing the relationship that a change in economic
activity causes investment in COE four years later, a statistically
significant relationship is found by one of the tests.
The results of the county-level analysis concerning cable and wire and
economic activity differ from the state-level findings. While there is no
evidence of a relationship at the state level, one of the tests for York
County indicates that a change in investment in cable and wire causes a
change in economic activity in the following two, three and four years.
Also, there is no evidence that economic growth in York County is
related to investment in cable and wire, even though tests show such a
relationship at the state level.
Somerset County is significantly less industrialized than York, with a
substantially smaller population. Still, the findings concerning invest-
ment in outside plant and economic growth in York County have some
support in Somerset County. Although for the most part statistical tests
for Somerset County fail to detect significant relationships in either
direction in the COE analysis, one test indicates that a change in

lELECOMMUN1CATIONS POLICY August 1993 427


Telecommunications infrastructure investment and economic development
investment in outside plant leads to a related change in economic
activity four years later.
To summarize, our findings indicate the following:
For both the State of Pennsylvania and York County, a change in
investment in central office equipment causes a related change in
economic activity in the second, third and fourth years; only in the
fourth year after a change in economic activity do we observe a
related change in COE investment.
A change in economic activity in Pennsylvania leads to a resulting
change in investment in cable and wire for all three time horizons
tested; however, a change in investment in cable and wire at the state
level does not cause a related change in economic activity.
A change in investment in outside plant in York County leads to a
change in county-level economic activity in the second, third and
fourth years.
Tests for Somerset County do not yield evidence of statistically
significant relationships between investment in COE and the eco-
nomy in either direction. However, in the fourth year after a change
in outside plant investment, a related change in economic activity can
be observed in the county. A change in county-level economic
activity does not lead to a related change in outside plant investment.

Appendix
Specifications and tests used in the analysis of causality

Standard regression analysis is one Both the Granger and the Modified any of a range of tests (eg an F test on
technique economists use to deter- Sims tests seek to determine evidence the joint significance of the lagged A
mine the statistical relationship be- of the causal role of A on B through an variables), then one concludes that A
tween two data series. Within this examination of comparative time ‘Granger causes’ B.
structure, however, causal rela- series representations. In the case of The Modified Sims test is a bit less
tionships are presumed. In order to the Granger test, an autoregressive intuitive. Again one considers
investigate, on a statistical basis, evi- representation of B is specified. The whether A causes B by considering
dence of causal ordering, special representation must include at least alternative time series representa-
methods are required. Therefore eco- enough lagged variables to reduce the tions. Here, however, one analyses a
nomists use other techniques to deter- resulting series of residuals to ‘white time series representation of the
mine causality. These tests seek to noise’ (ie no serial correlation). Furth- potentially causal variable A. The
determine the evidence of a causal ermore, B must be represented as a ‘base case’ representation involves an
relationship between two data series stationary autoregressive process. If autoregressive representation of A
by assessing whether the inclusion of the level B cannot be represented as a combined with lagged and contempor-
past information about one data series stationary process, an autoregressive aneous values of the variable B. As in
enhances the predictability of the representation of a first difference of the Granger test, this representation
second. B is considered, etc, until a stationary must be stationary and enough lagged
Statistical tests of causality were autoregressive representation may be variables must be included to render
proposed by Granger,25 building on made. A resulting autoregressive rep- the residuals series as white noise.
earlier work by Weiner.26 A thorough resentation is then considered against This base representation is compared
review of theoretical and practical another representation for the predic- to an alternative representation which
issues is presented by Geweke.” The tion of B. This representation includes includes not only the autoregressive
analysis of causality performed in this all the autoregressive terms of the first terms of A and lagged and contempor-
study involves the application of a but includes also lagged values of the aneous values of B but forward values
Granger test and a similar test prop- variable A. If the inclusion of the prior of B as well. A is said to ‘cause’ B if
osed by Sims,‘* later modified by history of A enhances the predictabil- the inclusion of the forward values of
Geweke. ity of the variable B, as indicated by B increases the predictability (as mea-

429 TELECOMMUNICATIONS POLICY August 1993


Telecommunications infrnstructure investment and economic development
sured, eg, by an F test on the joint While the two tests are similar in by the appropriate degree of dif-
significance of the forward values of concept, they are not mathematically ferencing. The presence of a trend will
B) of the time series representation of linked. It is possible to reject the null reflect itself in unit roots to a charac-
A. A more formal mathematical pre- hypothesis of no causality using one teristic equation associated with the
sentation of these tests is given below. test while failing to reject the null specified autoregressive process. To
hypothesis using the other. identify the presence of unit roots, the
The Granger test of causality The structure of causality tests re- Dickey-Fuller test was applied. A
l%e Granger test asserts that n is quires the specification of some sort of second-order autoregressive process is
caused by y if information about y autoregressive process. In structuring represented as:
helps to improve the forecast of x. It the specification, two questions
involves the consideration of two emerge. First, what is the appropriate (1- g@- g2B2) x, = g0 + e, (5)

equations: lag structure, or order, for the pro-


cess? Second, does the existence of a where B is the lag operator and e, is an
trend in any or all series bias the error series. For stationarity of this
results? If, in fact, a trend does exist, a process, the roots of the following
corollary question arises concerning quadratic:
the appropriate level of differencing to
remove this trend. l-giz-g22= 0 (6)

Determining appropriate lag structures are required to satisfy 1z 1 > 1. If z1 =


The forms above are general with l/n and z2 = ‘/m, then the autoregres-
where sive process may be represented as:
respect to lag structure. To apply the
= set of variables to predict tests to a study of causal relationships
x (1 - a@(1 - mB)xl = go + e,
between (constant-dollar) telecom- (7)
b = coefficient on x
munications investment and real per-
Y = set of variables against which sonal income, a particular lag struc- and then:
to test predictability
=
ture must be specified. To determine
C coefficient on y Dx, = go + (a - l)(l - m)x,i
=
an appropriate lag structure, LaGran-
U white noise + amDx,i + e,
gian Multiplier (LM) tests must be run (8)
t = time
=
on the residuals of estimated autore-
s number of periods where D is the difference operator.
gressive processes for each. If the
order of the specification is inadequ- The existence of a unit root would
The Modified Sims test of causality cause the coefficient of xc-i to become
ate, residuals will bear information in
The Modified Sims test is an extension the form of autocorrelation. The zero. A test for unit roots can then be
of Granger’s test of causality. It in- appropriate lag structure will reduce conducted by estimating the specifica-
volves the consideration of two residuals to white noise. The null tion above and checking the statistical
alternative equations: hypothesis is that the residuals are significance of the coefficient of xhl.
serially uncorrelated. The distribution of the test statistic,
DRI performed LM tests on every however, is not equal to the t distribu-
general autoregressive specification tion, not even asymptotically. Test
yr = i: by-s + i: h.~x, + “31 (3)
s=l s=o considered in the causality study to values for particular sample sizes are
determine the minimum lag structure given by Fuller. 2g More recently a
sufficient to reduce the residuals of the comprehensive set of critical values
autoregressive representations to for virtually any sample size was pre-
white noise series. On this basis, it was pared by MacKinnonU) For these tests
established that at least second-order the critical value at the 0.05 level of
where specifications should be used in the significance is approximately -3.0; at
Granger and Modified Sims tests. the 0.01 level of significance the critic-
Y set of variables to predict al value is approximately -3.7.
h : coefficient on y Determining the presence of trends
n = set of variables against which Given a determination of the lag struc- Dickey-Fuller test results
to test predictability ture, it was necessary to ascertain Dickey-Fuller test results varied by
b = coefficient on x whether or not a trend existed in the communications equipment segment
= white noise underlying relationships. For accurate
V and, to some extent, geographic de-
= time parameter estimates and tests it is
t finition. When the analysis was ap-
= number of periods necessary that any trend in the specific
s plied to time series of cable and wire
autoregressive process either be ex- investment levels and every invest-
The variable y is said to cause x if the pressed explicitly or be removed. The ment level series organized on a
future lags of x are jointly significant. removal of trends is typically achieved county-specific basis, the tests re-

TELECOMMUNICATIONS POLICY August 1993 429


Telecommunications infrastructure investment and economic development
jetted evidence of time trends, and differences, ie the data used for each 25Granger, op tit, Ref 15.
consequently causality analyses were year were the changes from the pre- “N. Weiner, ‘The theory of prediction’, in
E.F. Beckenback, ed, Modern Mathema-
conducted on level series for these vious year. Consequently causality tics for the Engineer, McGraw-Hill, New
equipment segments. For time series analyses for central office equipment York, 1956.
of state-wide central office equipment, involving two- and three-year autore- “Geweke, op tit, Fief 13.
however, Dickey-Fuller tests revealed gressive specifications were conducted “% .A . Sims,. ‘Money, income and causal-
ity’, American Economic Review, Vol 62,
evidence of time trends for two-year using first differences. Causality re-
1972, pp 540-552.
and three-year lag structures. Subse- sults obtained using first differences 29N. Fuller, lntruduction to Statistical Time
quent tests showed first-differencing may also be imputed to level move- Series, Wilev. Chichester. UK. 1976.
to be sufficient to render such speci- ments, since the levels are recovered 3oJ MacKi&on, Critical. Values for Co-
fications stationary, eliminating the through an integration of the first dif- in&ration Tests, Working Paper, Depart-
ment of Economics, University of Califor-
evidence of a trend. For this reason ferences. Problems of specifications nia, 24 January 1990.
causality tests presented in this study with over-differencing are presented 31MiIIs,op tit, Ref 19.
were performed using variable first effectively in Mills.3’

430 TELECOMMUNICATIONS POLICY August 1993

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