Disconnected

It has been hailed as the development tool of the century. It has revolutionized business in Africa and Asia and has allowed the poor to cross countless institutional hurdles. And despite a paucity of electricity, infrastructure, and support services, the people of the developing world have embraced it with open arms. It is the cell phone, and it is changing the reality of economic opportunity. With cell phone technology it is possible for health-care workers in rural Africa to summon ambulances to remote clinics. It is possible for one woman on the Congo River, completely illiterate and lacking electricity, to operate a successful food distribution business that connects with restaurants in distant cities and towns. It is possible for migrant workers without a reliable postal service to send messages in a matter of minutes.

Even more promising, there is increasing evidence that cell phones really do make developing nations better off by boosting overall economic performance. According to the Financial Times, studies show that a 1 percent increase in mobile diffusion “increases GDP per capita from US$124 to US$164 in the developing world.” Moreover, the size and cost of mobile equipment has decreased in recent years, such that the adoption barrier has declined dramatically and mobile technology has become easier to integrate. However, despite the recognized benefits of cell phone diffusion, only a small number of people in the developing world—indeed, only 5 percent of the population in India and sub-Saharan Africa—own cell phones. Why has the developing world failed to adopt the technology more widely?

The greatest barrier to mobile integration is excessive regulation and taxation. A cross-country analysis of the developing world conducted in 2005 by the Global System for Mobile Communications Association (GSMA) shows that, even after controlling for GDP per capita, a 10 percent decrease in the average annual cost of mobile services (taxes included) would increase mobile diffusion by 5 percent. In other words, in developing countries where mobile services are heavily regulated, and therefore more costly, cell phones are significantly less accessible to the population. Excessive taxation and costly regulation not only cause inefficiencies that distort the market for mobile services but also halt the spread of cell phones to the people whom the technology would benefit most.

Undermining Growth

Why is the mobile telecommunications industry so heavily regulated? Due to the economic promise and positive social externalities of cell phones, many governments in the developing world have begun to conceive of cell phone networks as a public utility with social benefits—much like water, electricity, or fixed landlines. Many of these governments have instituted regulatory safeguards—just as they would for public utilities—to prevent private firms from gaining unfair advantages and benefiting from frenzied demand for the new technology. Because many mobile providers in the developing world are foreign firms or are backed by foreign interests, governments fear that their countries will not benefit from the immediate financial gains of new mobile technology and that the money will flow right back to developed nations. Moreover, as economist Howard Gruber has reasoned, mobile technology in some countries has faced stringent regulation because of the competition it brings against fixed landlines, most of which are owned by the government itself.

Of course, some degree of government regulation is necessary to manage competitive resources in the mobile telecommunications industry. As per international law, governments maintain full control over radio frequencies and reserve the right to assign and price frequency license fees. Such regulatory control is beneficial for two primary reasons. First, as radio waves become increasingly congested, a central authority is needed to allot and oversee frequency usage. Second, fees can serve as reimbursements for the cost of making particular radio frequencies available, which may involve removing the previous user and making arrangements with the international community to avoid frequency overlap.

Excessive regulation, on the other hand, includes heavy import duties on cell phones, overpriced and arbitrary license fees, service activation fees, and special communications taxes. Over the past five years, governments in the developing world have imposed new varieties of taxation that are commonly introduced during the critical introductory stage of mobile technology. Today, according to the GSMA, the average variable tax on cell phone services in the developing world is 17 percent—with some taxes as high as 25 percent per annum—and the average tax (including import duties) on a physical handset is 31 percent. In fact, in one-third of the developing world, taxes represent more than 20 percent of the total cost of owning and using a mobile phone. In these countries, the average mobile phone user pays more than US$40 a year in taxes on handsets and mobile services, with some users paying annual cell phone taxes as high as US$179.

When analyzed on an individual country basis, the statistics appear even bleaker. In the Democratic Republic of Congo, subscribers pay a 33 percent tax on a new mobile phone. In Ghana the tax rate is 32.5 percent; in Syria it is 45.6 percent. Turkish cell phone subscribers are required to pay a monthly sales tax of 18 percent along with a special communications tax of 25 percent. Additionally, they are charged a special tax of 20 lira (US$15) above and beyond the price of each new mobile connection. In Uganda a 10 percent special tax has been levied on the purchase of each mobile phone, beyond the 27 percent that Ugandans must already pay in import tariffs because few reliable phones are produced domestically. And in Afghanistan, according the Economist, taxes on private telecommunications providers account for 14 percent of all government revenue.

The heavy taxes levied are even further exacerbated by license conditions that inadvertently support monopolistic market structures. In China the need to obtain complex licenses and expensive permits impedes market access to new mobile service providers. Successful entrance into the Chinese mobile service market can take one to two years of waiting for license review, along with a hefty amount of bribery. Economic researcher Alec van Gelder has found Ethiopian regulation to be so stiff that a single communications operator has developed a complete monopoly over service, with little incentive to improve the service or decrease the consumer price. As a result, it costs nearly US$100 to subscribe to the cell phone service in Ethiopia, where the average person earns US$700 a year. Accordingly, for every 1000 people in Ethiopia, only one has a mobile phone, whereas in neighboring Kenya and Uganda, 50 and 30 people, respectively, per thousand are phone owners.

Perhaps most detrimental of all, however, is the unreliable administration of taxes and regulations. According to Andile Ngcaba, the Director-General of the Ministry of Communications of South Africa, many African governments are ambiguous and inconsistent in their administration of taxes and licenses. If true, mobile service provision in Africa may be viewed as a risky venture subject to ever-changing and increasingly stringent regulation and taxation—a high business risk that chases potential investors away. This means that mobile service, an ostensible public utility with recognized social benefits, may be seriously underprovided.

For consumers, uncertainty about arbitrary and fluid tax rates also heightens the risk associated with the purchase of a cell phone. Rural African farmers whom cell phone service would most benefit often pass up low-cost offers because even a small increase in tax rates would render the service unaffordable and the purchase a wasted expense. While these farmers might realize long-term capital rewards from the use of cell phone technology, ever-variable taxes and service charges are a risk too heavy to bear when disposable income is scarce. In this sense, the risk caused by uncertainty further exacerbates the slow rate of cell phone diffusion in the developing world—a risk that can be remedied only by clear, unambiguous policy.

The Taxation Effect

The financial and social costs of excessive mobile taxation are immense—for firms, for consumers, even for governments. As taxes increase, so does the cost of mobile services, which, as reported by GSMA, exhibits a -0.49 correlation with mobile diffusion. That is, for every US$2 increase in the cost of cell phone usage, the number of mobile users in that country decreases by one percentage point. This negative correlation is especially significant when mobile diffusion rates are already low. In Kenya, for example, where only 5 percent of the population owns a cell phone, a US$2 increase in the total cost of using a mobile phone would wipe out one-fifth of the country’s mobile users. In this way, higher taxes on cell phone services significantly decrease dissemination of the technology, which in turn undermines the social benefits to all parties involved. The hailed weapon against poverty is denied to the people who need it most.

Strong evidence suggests that people would purchase more cell phones if there were less taxation. First, GSMA indicates that cell phones in the developing world exhibit an “own-price elasticity” of -1.0, meaning that there is a negative unit-for-unit trade-off between the price of a cell phone with taxes and the sale volume of cell phones in the legitimate market. If special taxes and import duties were lifted, an estimated 930 million more cell phones would be sold in unconnected areas of the developing world in the next four years. Additionally, if the cost of a cell phone in many developing countries decreased from above US$60 after taxes to just US$30, it is estimated that the total number of users would double.

There are also likely to be significant indirect or cross-price effects of changing tax rates, such that changes in legitimate prices will also affect consumer demand for cell phones in the black market. The GSMA found a strong positive correlation of 0.53 between prices of cell phones in the black market and prices in the legitimate market. This means that the higher the price of cell phones in the legitimate market, the greater the sales in the black market. Conversely, the lower the price in the legitimate market, the fewer the sales in the black market.

Consumer preferences in the developing world—where money is in short supply and most prefer to invest carefully—underpin this positive 0.53 correlation. Although two-fifths of cell phones are currently purchased on the black market, people would prefer to purchase affordable phones with a small tax on them than black market phones that cannot be returned or serviced if they turn out to be defective. Black market phones, along with most domestically produced phones, are so unreliable that even a small decrease in import tariffs would likely be mirrored by an exceptional increase in demand for legitimate market cell phones.

The distortional effects of excessive taxation and regulation are not limited to consumer incentives. Mobile phone producers and service providers have significantly altered their operations as well. In Brazil, as in other large cell phone markets in the developing world, cell phone producers have set up local factories to circumvent high import duties. Without import duties, phones cost less. And because demand for cell phones is so elastic, the lower cost translates to escalated consumer demand, higher rates of diffusion, and increased profits derived from economies of scale.

But setting up local factories for mobile phones is not profitable in all regions, especially in smaller and poorer countries where current demand is minimal and the market is undersized. In these countries, particularly in sub-Saharan Africa, service providers opt not to supply mobile phones at all. Instead, they rely on customers to obtain their phones via the black market. And in many cases, the distortional effects of taxation—and the consequently low demand—induce many service providers to pass up the market for mobile service altogether.

From the governmental perspective, moreover, the sheer number of cell phones sold in the black market translates into an immense loss in government revenue and regulatory power. Because 39 percent of all cell phones sold in the developing world, including China and India, are purchased on the black market, governments are missing out on sales-tax revenues from almost two-fifths of the market. GSMA estimates that, last year alone, governments in the developing world lost nearly US$3 billion in tax revenue. They will lose an estimated US$24.5 billion more in the next five years if people continue buying on the black market.

Even more ironic for governments is the effect of regulation on monopoly power. While developing countries seek to limit monopoly power through regulation, many inadvertently sustain monopolies in the process. Economist Howard Gruber notes that in most OECD countries, relaxed regulation in the mid-1990s paved the way for new mobile telecommunications entrants such that there are now three to four major service providers in each developed country where monopolies were the former norm. In the developing world, on the other hand, most mobile service providers enjoy pure monopoly status. Because heavy regulation and import duties slim profit margins and reduce consumer demand, it is nearly impossible for new entrants to acquire a meaningful market share. Like the single provider in Ethiopia, these monopolies have little incentive to improve or expand their services because regulation secures the unlikelihood of new entrants. In this way, again, excessive government regulation works at cross purposes: it actually impedes the beneficial spread of cell phone technology.

A Digital Future?

Cell phones make people better off, the poor most of all. But diffusion is hindered by excessive regulation and taxation, both of which choke the potential growth of this beneficial new technology. Consumers are wary of high participation costs and risks, and firms face the difficulty of turning a profit with low demand and difficult start-up conditions.

There is hope for the future. Over the last year, India cut its imports tariff on cell phones to 5 percent and has since indicated that it may end the tariff altogether. Mauritius has also reduced its taxes on mobiles. With the potential of the mobile market, moreover, it is possible to conceive of an “everyone wins” scenario in which consumers enjoy reduced taxes and thus lower prices, new firms enjoy diminished regulatory barriers, and governments enjoy increased tax revenue due to increased consumer demand. Such a scenario is contingent on government action—action that will involve a thorough reassessment of which regulations are necessary and which are harmful.

If the developing world is to narrow the digital divide, the effort toward change must begin at home. Governments should take action to stimulate—not impede—the spread of mobile technology. The real obstacle is not technological availability, nor even infrastructure, but rather the debilitating regulations and taxes imposed by governments across the developing world.

About Author

HIR

Leave a Reply