This extended essay is an edited version of some posts I submitted to a private email list. I thought I’d share them with you as the questions raised are important, and it’s a debate worth having.
There’s a gaping hole in our understanding of telecom. A yawning, jagged, iceberg-sized rip in the fabric of our knowledge. We’ve no idea how the world of bit-shifting interacts with the world of atom-arranging. How do telecom and transport substitute or complement one another?
This is kind of important. Trillions of dollars of immobile capital infrastructure are at stake if we misunderstand the relationship between physical and virtual transport. Would uncontended gigabit connectivity everywhere make cities’ populations explode or implode? What if all those freeways to the suburbs become roads to nowhere (ever more than they are now)?
Substitution and elasticity, an introduction
Many have claimed that slightly counter-intuitively, telecom and transport are complements, not substitutes. For example, cyberguru Andrew Odlyzko writes (p10):
While telecommuting and videoconferencing are likely to grow, that will not reduce road congestion. There is this strangely persistent myth (which I have traced back to the 1830s, and its origins are surely even earlier) that telecommunications and transportation are substitutes for each other. They are not, and are in fact positively correlated. Hence we should expect growth of travel at the same time as telecom usage is booming.
I’m not sure if this is always true. The exceptions to the above claim might be important for how our human geography changes.
Three definitions that enable us to have a meaningful debate. Income elasticity is how the fast consumption of a good varies with total income. Price elasticity is likewise, but for price. Price cross-elasticity is how the demand varies with the price of some other good. It is the direction of the cross-elasticity that defines whether a good is a complement (guns and bullets), or a substitute (guns and crossbows).
Reasons to be suspicious of the claim
So why should we doubt this claim about telecom and transport being complements?
Firstly, correlation isn’t causation. After all, the stork population of Denmark apparently tracked the birth rate rather well for a long time.
There is also a misunderstanding what substitute or complementary goods really are, in the technical sense. The positive income elasticities of travel and communications may swamp any substitution cross-elasticities in a period of rapidly rising incomes. This is to say, the effects of getting richer outweigh the effects of getting relatively cheaper. Trending over time isn’t enough to separate out the cross-elasticity from the income elasticity.
Indeed, it is not uncommon for goods to have opposite price and income elasticities, and in the extreme this can lead to the paradox of Giffen goods where consumption actually rises with price at the same time as real incomes fall. Telecom might possibly be such a good; it would be very exciting if it were demonstrated to be so, since real examples are rare to non-existent. It would be interesting to track the price and usage of telecom in places like Iraq where 20%+ income falls are the norm.
Secondly, we’re only just beginning to have telecom of a grade where the sense of “being there” resembles in any way a substitute for actual travel. There may be a point in the graph where past relationships break down. We could sub-segment our market into “travel for information exchange” vs. “travel for sense of presence”, and might find substitution occuring in the former already, and the latter impending.
Thirdly, there may be a hysteresis effect. Telecom and travel have large fixed capital assets, but telecom has low operational costs. Rising incomes stimulate telecom demand in a virtuous circle. But falling real incomes don’t make the infrastructure go away, and the low operational costs of telecom may indeed cause substitution. This scenario would be in play following a large oil price shock.
Fourthly, we can also see limits to growth in travel that don’t exist in telecom. If there are complements, travel is going to run out of runway:
Meaningful debate needs meaningful terms
Lastly, and most importantly, “travel” and “telecom” are not necessarily single monolithic things that can be meaningfully reasoned about side-by-side. Travel comes in three broad forms, each of which has different price, income and cross elasticity. The three forms are “travel as producer transport”, where the travel is incidental to your producing some other economic good; “travel as consumer transport”, where it is incidental to consuming other goods and services (e.g. shopping or restaurant visits); and “travel as consumer application”, where it is an end in itself (e.g. going to Greece on vacation).
These last two are clear telecom complements via e-commerce and social computing. Travel incidental to consumption is only substitutable to the extent that the desired end good or service can be replaced by an information good. But Zagat restaurant guide isn’t much of a replacement for a real dinner, so this isn’t normally the case. Information goods are normally deficient substitutes for physical consumer experiences. Plus there’s no real telecom substitute for actually standing in the Parthenon. The income effects of better information and network technologies swamp the price substitution effects anyway. The more you earn the more you travel to consume, regardless of marginal price substitution of travel and telecom.
The exception case is “travel as producer transport”. This appears to have unusual and interesting price and income elasticity curves, which may contradict the claim that travel and telecom are complements.
At the very low end the ability to travel at all is a status symbol. But for the worker classes in developed countries, people have to be paid to commute or stay in business hotels because it is boring and unpleasant. Every management and IT consultant out on the road whinges endlessly about the travails of travel. The inconveniences of being an oil explorer or truck driver generate premium wages compared to comparatively skilled occupations. You only seek to spend time with work acquaintances in inverse proportion to having a real life. But go a bit higher up the income scale and the boss will stay at the head office while the salesmen run around the client sites. At the very high end, you want to show off the executive jet, and travel becomes desirable again. This makes for a strange, wiggly income elasticity curve. Substitution may occur in patches.
To make a higher personal income you need to specialise, and that means your contacts come from a smaller global pool that you’re more likely to have to travel to meet. So as incomes rise people are obliged to do more of it despite its increasing unattractiveness with respect to leisure alternatives. It’s a hard call on as to whether commuting and business travel is an “inferior” good (negative income elasticity — willing to pay less as income rises).
Does substition exist?
Thought experiment/sanity check: if we had universally accessible and perfectly immersive VR meeting and presence systems available (i.e. a huge drop in telecom prices), would business people, consultants and workers travel as much? Probably not, unless there was a free lunch involved. So these appear to be price substitutes, not complements, when you factor out income effects.
So we can at least dream of a case of substitution occuring, as an existence proof. In my mind I already have several more concrete existence proofs of substitution:
Much business travel is very mundane and once you’ve established an in-person rapport the only reason for continued physical presence is because today it’s too darn hard to mimic a whiteboard and manic arm waving using NetMeeting. Even eye-to-eye sales can see substitution: you get telemarketing calls trying to sell you double glazing as well as door-to-door calls. Changes in the prices of oil and phone calls would change their relative demand. These may be complements and substitutes in different situations. But when? I don’t know.
Price shocks to test cross-elasticity
Suppose we anticipate a two price shocks. The first is a massive universal decrease in the cost of connectivity because of cheap long-haul fiber and user-built municipal meshes. Everyone gets a zillion-dollar OC-192 into their home for ten bucks a month. This would probably greatly erode the desire to commute, reducing the attractiveness of central business districts and increasing the wish to live in smaller towns near to recreation and shopping facilities. So your billion-dollar fixed public transport network with a hub-and-spoke architecture might be a waste of money. Or in other words, y’all move to the Red States.
The second possible price shock is a calamitous increase in the cost of travel because of the hypothesised Peak Oil effect and lack of scaleable energy substitutes. (The jury’s still out, you make up your own mind.) This will have a large negative income effect on society. This might greatly increase the demand for business travel as people strive to reclaim the former income levels. The effect on telecom depends on whether it turns out to be a Giffen good — to me, an open question. The price effect of a substitute good (business travel) rising in cost might boost the demand for telecom. Who knows - it’s hard to tell which effect wins. But the Blue States look like nicer places to live in this scenario. (If you’re broke and homeless, at least you can sleep with the beautiful people.)
Conclusions
The separation of the “tele” from the “com” suggests we should be looking separately at the layers of the architecture. That means considering the information services separately from the bit haulage. What’s the price cross-elasticity of going to NASCAR races with car-racing TV shows and video games? And will that have the same effect on connectivity demand? I suspect the answer is we know even less at this level of detail than we do at the aggregate level.
As Andrew Odlyzko also observed (p8), nobody’s ever properly studied and documented the history of price discrimination in network industries.
There is no definitive treatment of the history of pricing in various network industries. Even some basic questions, such as the nature of the “just price” doctrine of medieval scholars, are still being debated.
Unfortunately, I’ve also yet to see a good model for how telecom and travel are related, which might cost us dearly in the future. This is despite it being the core motivator for (at no exaggeration) trillions of dollars of annual economic activity. It would be no surprise if we were equally in the dark about telecom and travel cross-elasticity.
If someone isn’t working on a PhD thesis in this area, they should be.
In conclusion, (i) blanket statements about how bit movement and atom movement relate are unlikely to be valid, (ii) even given our low level of knowledge, there are likely to be significant (read: “billions of dollars”) local substitutions as incomes and relative prices vary, even if globally aggregated data hides those (iii) the interesting problem is finding under what circumstances information goods substitute or augment the consumption of physcial transport, and, (iv) there’s a lot of money riding on this.
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"No telecom good I can think of is positional."
Surely the private telephone numbers of celebrities are positional goods. Access is tightly restricted, and the numbers are changed regularly to make sure only they are only known to a select few. Unknown people don't get to make casual calls to Bill Gates mobile, any more than they can make casual visits to his private office.
Does this count?
Posted by: at January 20, 2005 11:42 AMI'm still trying to understand positional too.
Surely the limitations of the namespace are positional (though you can create more namespaces". There's only going to be one 1-800 STARWARS in the same way as there there only going to be one STARWARS car licence-plate. Doesn't each namespace have positional properties? If not, how come there is such a market for them, and so much interest in the dispute process for reconcilling them?
Posted by: at January 20, 2005 05:42 PM"Information goods are normally deficient substitutes for physical consumer experiences."
Search and linked browsing, regarded as 'management of ignorance' are generally successful information goods. (Google will often give you a few good (consumer) things to look at, but more importantly allows you to ignore the many billions of less-relevant items). Search is a messy business, and the more glamorous and less successful 'knowledge management' part of search is less successful.
Interestingly, 'management of ignorance' has one (negative, unsurprisingly) case where the information good is a complete substitute for a physical consumer experience. A search can tell me that I don't want to go to any restaurants in Chapel Hill (because I only want Indian and search reveals none open at the times I want to go).
In contrast, if I relax my preferences to allow more times or more food styles sucessful search merely modifies my set of choices (should I eat locally or drive 30 minutes to Chapel Hill?).
Posted by: at January 29, 2005 03:41 PMGreat Think Piece,
I've been thinking about this from a slightly different angle, I live in New Zealand and do a lot of work with CityLink (www.citylink.co.nz) a municipal fibre operator in Wellington and as a self proclaimed "Marketing Weasel" my role is to articulate the benefits of really high speed connectivity (up to 1GB/s) We surveyed customers a couple of years ago to explore among other things the "substitution effects" of very fast connections, interestingly most of them were IT related but they also cut across printing and distribution, travel was harder to measure but was seen as a future benefit. Since then I've also become involved in the NZ Governments program to roll out broadband to provincial and regional NZ and I now see 2 benefits emerging very strongly one is the idea of "Location Independence" (Red stating for Blue staters - we've done our own version of this!) and the other is "Isolation Reduction) (Blue State services for Red Staters!) so I fully support your view that their is a substitution effect for some "Production" related travel, and now living in a regional setting I can see 2 other areas that will change, one is travel for training and education and the other is distributed workgroup collaboration but I don't think we'll ever give up social travel - I think its too deep in our Nomad Genes
Interestingly they are building new tropical islands for the wealthy
Palm Islands in Dubai!
Hi Martin,
Great posting! Makes one think, definitely.
Let me toss in a few of my observations. I recently posted on the peak oil phenomenon and argued it will be a catalyst for greater online activites, and whether there is a "strong negative correlation" or only a slight negative correlation, I am quite certain that as price of oil increases dramatically - and whether you want to project 5 years into the future or 50, most experts do agree that fossil-fuel based oil will be peaking and after that we will be desperate for substitutes. Life-sustaining energy will be a premium (heating, water delivery, electicity grid for example) and discretionary travel will suffer in that contest of the resource. I am very certain price of leisure travel will increase dramatically in the next decade, from cars to air travel.
At the other side, we have a continous quite pronounced drop in overall telecoms price levels. And the technologies to allow virtual presence, from video conferencing to 3G videophones to virtual reality worlds, will keep on getting better.
From living through the first oil shocks in the 1970s I remember there was a global push to limit discretionary usage of energy - such as many cities shutting down all lighted outside advertising eg billboards etc. There will be another oir shortage sooner or later, and the immediate reactions will be quite severe. At that time if you ask your boss for permission to travel to a client, his standard reply is why can't it be done over video conferencing (or other online collaboration or whatever).
For more your readers might enjoy my blog about this topic at this link:
http://communities-dominate.blogs.com/brands/2006/05/as_oil_peaks_ro.html
But then on what Andrew wrote about. A good observation, it is not that for all communication and travel, there is a negative correlation. I personally have been very closely involved in the creation and evolution of the mobile telecoms services space, from my books, Oxford lectures, and working with the biggest mobile telecoms players around the world such as Nokia, Ericsson, Vodafone, NTT DoCoMo etc. I've been particularly tracking the SMS insights as they are a precursor to the what we might experience in the "3G" next generation mobile data world.
We've observed very clearly that SMS usage increases with proximity. The closer you are to someone, the more you send messages to them.
Conventional wisdom suggests otherwise. We are apart, we miss our friends, we send text messages. And yes, there certainly will be a LITTLE bit of that. But the vast majority is that we are about to meet our friend today, we text. We run a bit late, we text. We are lost and trying to spot our friend, we text. We meet. Then we depart, and we text. We remember something funny, and we text. Tomorrow we still text. There is a very pronounced pattern that with proximity to our given friends and colleagues, we send many more texts than when we've been apart for long either in time or distance.
With this, I am tempted to agree with the concept that there is a positive correlation with telecoms spend and travel. That more travel specifically CAUSES more spending.
I think both concepts work, and am not at all ready to even venture to guess which will "dominate" in the big picture. But yes, I've seen the numbers many times, that close range delivers more telecoms traffic, calls yes, but even more clearly more text messaging traffic. So if we travel "more" and meet with our various contacts more, it would result in more of this type of messaging. Obviously if I fly from London to visit my friend in Singapore, I will exhibit this same behaviour, regardless of the distance involved. But I would "forget" my Singapore friends if I only stayed in London, and might only send a birthday greeting or something like that to my Singapore friend. Note also, that while I'm on my Singapore trip, I'll still maintain my contacts with those who I recently met in London, but the longer the Singapore trip becomes, the less I'll be inclined then to continue texting with my friends in London.
Make sense? Am not sure. But I'll think more about this.
Thanks for the posting ! Great thinking. And I agree with you, this is a great area to study.
Tomi T Ahonen :-)
4-time bestselling author and consultant on mobile
founding member Forum Oxford, Wireless Watch, Carnival of the Mobilists and Engagement Alliance
website www.tomiahonen.com