Is there a link between IoT and productivity growth?

Is there a link between the number of IoT connections per inhabitant and total factor productivity growth? In a research article conducted in collaboration with Imperial College of London, Ericsson Research provides the evidence to suggest just that. In our latest blog post, we dive into the data and explore the potential impact that IoT could have on economic development.

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Master Researcher, Macroeconomics

Master Researcher, Macroeconomics

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The Nobel laureate Paul Krugman once wrote: “Productivity isn’t everything, but in the long run it is almost everything” (Krugman 1994). Productivity is crucial in spurring economic development, which in turn creates a wide range of new opportunities that enable people to escape poverty. History has shown that new technology is important in driving productivity growth (Edquist and Henrekson 2006). Moreover, increasing productivity will be most urgent for countries wanting to recover from the economic turmoil caused by the Covid-19 pandemic.

Is the world on the cusp of a fourth industrial revolution driven by technological developments in ICT, including the Internet of Things (IoT)? In a research article conducted in collaboration with Imperial College of London, Ericsson Research finds evidence of a link between cellular IoT connections and productivity growth.

The results suggest that a 10 percentage points increase in the growth of cellular IoT connections per inhabitant is associated with a 0.23 percentage points increase in total factor productivity growth, which amounts to a contribution of USD 197 billion, based on world GDP in 2018.

Since the Industrial Revolution, major technological breakthroughs have changed how we lead our lives and produced goods and services. These are often defined as General Purpose Technologies (Bresnahan and Trajtenberg 1995). According to this view, whole eras of technical change are driven by pervasive technologies with inherent potential for progress and innovational complementarities, giving rise to increasing returns to scale. In this framework, IoT can be considered an innovational complementarity based on technical improvements in ICT.

IoT across the globe

IoT cellular connections have been growing very rapidly during the last decade. As shown in figure 1, the growth in absolute figures has been particularly strong in China. The annual growth worldwide has been 40 percent, while the corresponding figure for China is 70 percent. Moreover, China had the second highest share of cellular IoT connections per capita. Sweden was the only country with a higher density (GSMA 2020).

Figure 1: Number of total cellular IoT connections in the world (in millions). Source: GSMA (2020)

Figure 1: Number of total cellular IoT connections in the world (in millions). Source: GSMA (2020)

 

It is argued that IoT will impact both consumers and industries. The latter will be observed in measured productivity, but the former may not if time-savings, free goods or quality improvements are not (fully) reflected in measured prices. We argue that productivity effects will occur via two channels. Firstly, via capital deepening (an increase in the capital to labor ratio), as firms invest in connectivity equipment for their machines. Secondly, in the form of total factor productivity (TFP) growth, which may be due to increased efficiency and optimization in the production process, complementary innovation, and the accumulation of complementary intangible capital, including organizational capital and spillovers or network effects from the accumulation and deployment of communications capital (Goodridge, Haskel and Edquist 2018).

Based on data from 82 countries in 2010–2017, we find a strong association between the change in IoT connections per inhabitant and TFP growth, suggesting large effects in the early stages of diffusion. We note that this is consistent with Waverman, Meschi and Fuss (2005).

We observe growth in IoT connections per inhabitant of 30 percent per annum in our sample, implying a yearly contribution to TFP growth of 0.69 percent, a large effect. This is equivalent to a contribution of USD 592 billion, based on world GDP of USD 85,804 in 2018. Even though this study is based on data before the world economy was hit by the Covid-19 pandemic, increasing productivity will be a key factor to a quick economic recovery.

IoT and economic development

To further test the robustness and provide a cross-check on our econometric results, we proceed with growth accounting methods (Solow 1957; Jorgenson and Griliches 1967). Growth accounting implies that economic and productivity growth is decomposed into components associated with changes in factor inputs and a residual that reflects technological progress and other elements.

Our analysis distinguishes between the capital deepening and TFP effects of IoT. Of that, the capital deepening effect of IoT turns out to be relatively small. This is because, while the projected rates of IoT investment growth are high, the associated user costs and factor income share will be initially low, since IoT is a new technology. At later stages of diffusion, growth rates in investment and capital services will slow, and IoT user costs and the income share will rise in line with the higher level of the capital stock. Our analysis suggests that the indirect effects of IoT on TFP growth may be considerably larger.

Using estimates of current IoT investment and the investment profile observed during the previous wave of the ICT revolution, we find a substantial IoT contribution at around 0.99 percent per annum of growth, which is equivalent to USD 849 billion of global GDP. Moreover, our analysis shows that the key parameter in forecasting the IoT growth contribution is the starting value for IoT investment, for which no official data are yet available. Thus, our results are quite sensitive to the assumptions made about the initial starting values of IoT investment.

Total factor productivity is economic growth not attributed to inputs of capital and labor and therefore, productivity achieved by using new technology and smarter organization of production. As a result, total factor productivity is achieved without additional inputs of resources. Productivity play a key role in spurring economic development and creating a range of new opportunities that enable more people to escape poverty. Hence, increased productivity will release resources that make it possible to improve other important sustainability goals such as health, pollution, security and education.

Read the full research article:
Edquist, Harald, Goodridge, Peter and Haskel, Jonathan (2019), The Internet of Things and economic growth in a panel of countries, Economics of Innovation and New Technology, forthcoming.

References:

Bresnahan, Timothy and Trajtenberg, Manuel (1995), “General Purpose Technologies ‘Engines of Growth’?”, Journal of Econometrics, vol. 65, pp. 83–108.

Edquist, Harald and Henrekson, Magnus (2006), “Technological Breakthroughs and Productivity Growth.”, Research in Economic History, vol. 24, pp. 1–53.

Goodridge, Peter, Haskel, Jonathan and Edquist, Harald (2018), “Productivity, Network Effects and Telecommunication Capital: Evidence from the US and Europe”, Working Paper, October 24, Imperial College.

GSMA (2020), GSMA Wireless Intelligence Database, Accessed April 17, 2020, www.gsmaintelligence.com

Jorgenson, Dale and Griliches, Zvi (1967), “The Explanation of Productivity Change”, Review of Economic Studies, vol. 34, pp. 349–383.

Krugman, Paul (1994), The Age of Diminished Expectations: U.S. Economic Policy in the 1990s, MIT Press, Cambridge MA.

Solow, Robert (1957), “Technical Change and the Aggregate Production Function”, Review of Economics and Statistics, vol. 39, pp. 65–94.

Waverman, Leonard, Meschi, Meloria and Fuss, Melvyn (2005), “The Impact of Telecoms on Economic Growth in Developing Countries”, In: Africa; The Impact of Mobile Phones, Vodaphone Policy Papers, no. 2, pp. 10–23.

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