What is Digital Economy?
Digital economy refers to an economy that is based on digital computing technologies, although we increasingly perceive this as conducting business through markets based on the internet and the World Wide Web. The digital economy is also referred to as the Internet Economy, New Economy, or Web Economy.
The digital age is transforming everything: the nature of markets and products, how to produce, how to deliver and pay, the scale of capital to operate globally, and human capital requirements. It is also boosting productivity, exposing companies to new ideas, technologies, new management and business models, and creating new channels of market access. And all of this at relatively low costs. It is no exaggeration to predict that firms will increasingly rely on artificial intelligence for basic routines and for more complex tasks.
For digital technologies to impact economic development, however, appropriate policies have to be in place to remove the obstacles preventing emerging economies from fully engaging in the digital economy and optimising the benefits, while minimising the risks.
Seizing the benefits of the digital economy for development
- The growing share of intangible components in the final value of goods, coupled with the increasing ease of access to digital technologies, platforms, and advanced capital goods, are radically transforming our understanding of the production and distribution of wealth and cross-border trade.
- We are witnessing a growing division in the global economy between those who use and those who develop, distribute, and manage digital technologies and set standards.
- Digital commoditisation and the fallacy of composition are critical aspects of the digital economy and have substantial implications for economic development and income distribution.
This piece discusses the relationship between the digital economy and economic development and explores the benefits and challenges for emerging economies. It identifies two sets of benefits: the so-called first and second order benefits. While the former is related to the direct, more visible, advantages of accessing and using digital technologies by consumers, firms, and governments, the latter is related to the less visible – but far more relevant – benefits related to developing, managing, and distributing digital technologies.
The article makes use of the concept of digital commoditisation to help frame and examine those benefits and to identify the challenges that emerging economies may face as a consequence of this commoditisation.
While global trade in goods and financial flows appear to have peaked in terms of their share of GDP, data flows are growing almost exponentially. According to McKinsey, between 2005 and 2014 the flow of global data grew by a factor of 45, and is projected to grow by another nine over the next five years. In addition, data flows added $2.2 trillion to global GDP directly and another $2.8 trillion indirectly in 2014.
The expansion of connectivity, infrastructure, network-effects, falling computing and sensor costs, open software architectures, and the deregulation of digital markets are accelerating the adoption and use of digital technologies and enabling the emergence of a whole new generation of investment and business models.
However, while the dissemination of digital technologies is highly valuable for productivity, well-being, and the creation of wealth, it is necessary to take into account their limits because of digital commoditisation. This term refers to the impact that popularisation of access and use of standardised and general-purpose digital technologies have on competitiveness advantages.
It seems reasonable to assume that the impact of adopting a new digital technology on competitiveness follows a path similar to that described in Figure 1. When few firms in a given industry have access to a new technology, its impact on competitiveness will increase rapidly. However, if access and use of that technology are popularised beyond an optimal economic feasibility point (A), then the benefit of that technology will continue to grow, but at decreasing rates until its impact on competitiveness becomes insignificant.
Figure 1: The relationship between digital commoditisation and competitiveness
The dissemination of several digital technologies is therefore increasingly becoming an entry requirement and no longer a source of competitive advantage. That is, the new technology becomes a requirement to put the firm in the “game” but does not guarantee that it will “win the game.”
Failure to discern the relevance of digital commoditisation may drive one to the fallacy of composition – the error of assuming that what is true of a member of a group is also true for the group as a whole. Applied to the context of the digital economy, it can be a mistake to assume that, ceteris paribus, the broad adoption of digital technologies will necessarily continue to generate increasing returns in terms of productivity and competitiveness.
This concept can be illustrated with the case of the productivity impact that personal computers (PCs) had in the mid-1980s in simple activities such as text editing, inventory control, and accounting management. Access to PCs was limited to a few firms because of the high cost of machines and limited capacity of people to operate computers and software. Firms and universities that had access to PCs at that time experienced improvements in efficiency and performance indicators. However, over time, the use of PCs and software in basic and even more complex activities started to make less difference, as such resources became “commoditised.”
Information technology equipment, cloud services, standardised software for various purposes, web and device applications, and e-commerce and other platforms are also subject to digital commoditisation. Growing access to the internet, together with network and platform effects, are accelerating this commoditisation and expanding its scope.
The reach of digital commoditisation goes far beyond the virtual environment. Industry 4.0 and other new management and manufacturing technologies based on digital technologies – such as the internet of things, big data, artificial intelligence, machine learning, to name but a few – also fit the logic of digital commoditisation. This is because their developers are aiming to popularise those technologies as much as possible – even with lower margins of return. This makes sense since the more popular a platform becomes, the bigger the network-effect and thus the number of users.
This thus represents a complete change in business models as conceived until now. Although this change is more visible in the case of e-commerce and other virtual business platforms, it is also valid for hardware. Indeed, the next generation of factories and capital goods – for example robots and 3D printers – will run on a kind of pre-paid or pay-as-you-go management and production virtual platforms sitting in the offices of the robot, printer and other technology developers.
Digital commoditisation also makes low production costs a less relevant factor for international competitiveness. The growing share of intangible components in the final value of goods and the increasing ease of access to digital technologies, platforms, and advanced capital goods are radically transforming our understanding of the production and distribution of wealth and cross-border trade on a global scale. They even challenge the conventional notion of capital shortage and access to technologies.
In fact, the sharp fall in the price of robots and other sophisticated technologies, and cheap and quick access to markets via e-commerce platforms, are among the manifestations of this trend. Affordable and low-cost labour, tax incentives, and other conventional forms of attracting and retaining investment in emerging countries thus need to be reassessed.
Digital commoditisation also helps to explain the paradox of the slowdown in the rate of productivity growth and of the fall in the relative price of capital goods. This may indeed be one of the keys to understanding secular stagnation.
The benefits and challenges of the digital economy for emerging countries
First order benefits
The benefits of the digital economy for emerging economies are potentially large. That is because it can have significant competitiveness and productivity-boosting opportunities related to access to digital products and services that help optimise processes and production, reduce transaction costs, and transform supply chains. Declining information and communication technology (ICT) prices encourage investment and adoption of digital technologies in emerging economies, providing their firms with cutting-edge services at competitive prices. All of this enable firms to participate in global value chains and directly access customers in foreign markets in ways previously only feasible for large and established companies from advanced economies.
For consumers, the benefits are associated with access to a wider range of goods and services at competitive prices. It also offers new opportunities for entrepreneurship and job creation. Governments also benefit from the digital economy to the extent that they have access to technologies that help them deliver more and better public services, improve governance, evaluate policies, and deliver better results overall.
Yet many digital economy benefits have not yet materialised at scale, which is due to adoption barriers, lag effects, transition costs, and digital commoditisation.
It is widely agreed that governments of emerging economies need to work on several fronts in order to enable the digital transition and reap the associated benefits. These areas of intervention include reducing capacity constraints and improving skills; investments in ICT ecosystems, connectivity, and digital infrastructure; agreements to promote ICT adoption and diffusion as well as market access; regulatory frameworks that foster competition and market conditions; and policies to boost investment and innovation.
This policy agenda is key to accelerating technology adoption and reducing digital divides in emerging economies, which will have undeniable positive effects on firms, consumers, and governments.
There are also development challenges related to the digital economy that have to be taken into account, of which the most important is perhaps digital commoditisation and the fallacy of composition. It is reasonable to suppose, for example, that the increasing participation of small and medium-sized enterprises in e-commerce is likely to reduce marginal benefits.
Digital commoditisation could also check the prevailing model of fragmented production. As stated, digital technologies are rewriting the conditions and geography of production, and they enable the manufacture on a competitive basis of sophisticated and simple goods, for example sport shoes and T-shirts. This is likely to disrupt markets for highly dependent garment suppliers such as El Salvador and Bangladesh, with these technologies behind the so called “reshoring,” that is the return to advanced countries of industrial plants previously operating in low-cost economies.
Second order benefits
In this new global context, it is important to distinguish “use” from “development, distribution, and management” of digital technologies. While the vast majority of businesses are mere users of digital commodities, a much smaller share falls into the category of developers, distributors, and managers of those technologies. The actors in this latter category are the ones defining the standards and the platforms on which digital commodities and cross-border trade are operated and employed.
Countries that have firms acting as developers of platforms and managers of digital technologies are those most likely to reap the second order benefits that arise from the digital economy – i.e. better prospects in terms of long-term growth, job and wealth creation, and lasting positive effects on productivity and competitiveness. Their populations and firms are those that tend to benefit the most from the indirect effects of being in a richer, open, and innovative environment.
Indeed, companies such as Google, Amazon, Apple, Microsoft, Facebook, Baidu, Alibaba, SAP, PayPal, AT&T, Uber, Tencent, Cisco, Oracle, Huawei, Siemens, Bosch, and others are developing digital devices and platforms in which third companies operate using predefined standards within a given framework. Shortening technology life cycles along with network- and platform-effects are establishing a highly asymmetric “winner-takes-all” model in which the “superstars” maintain competitive advantages, keeping them well ahead of digital commodity users.
Although participation in e-commerce platforms allows firms from emerging economies to theoretically reach millions of consumers worldwide, presence in such platforms is not neutral. A blockbuster factor combined with other discriminatory practices reinforce the algorithm effect that drives consumers to the most researched firms and items. As a result global e-commerce platforms provide a long tail of vendors, but only a select few are likely to be successful.
In other words, competition may be limited by discriminatory policies, including non-neutral treatment and inadequate enforcement of competition rules, thus leading to cross-subsidisation.
Moreover, to the extent that platform developers set the rules of product and service development as well as marketplace interaction, this affects access, market conditions, and prices. But perhaps the greatest value of platforms stems from data extracted almost for free from users. But considering that most of this digital data are in some form personal, then they may not be treated as a commodity.
In e-commerce, ceteris paribus, the marginal benefits for a typical vendor participating in a given platform may decrease the higher the number of vendors. By contrast, the marginal benefits for platform developers may increase the higher the number of participating vendors. So, while the first order benefits may have decreasing returns, the second order benefits may have increasing returns, as suggested in Figure 2.
Figure 2: First and second order benefits
The winner-takes-all dynamics combined with network- and platform-effects thus have massive implications for competition. With data collection and analytics increasingly crucial for the rise of new services and solutions, it is becoming ever more difficult for an entrant to challenge incumbents.
Big e-commerce firms and platform developers are therefore in a position to capture a significant and growing share of the private benefits of digital commodities. This could be one of the explanations behind the demise of "unicorns," start-ups worth about $1 billion that have been either crushed or acquired by the superstars.
Consequently, we are witnessing a growing division in the global economy between those who use and those who develop, distribute, and manage digital technologies and set standards. The first group is largely composed of emerging and developing countries and even some high-income economies, who capture some of the first order benefits. The second is largely composed of advanced economies such as Germany, Japan, Sweden, and the United States, as well as China.
By focusing on first order benefits and overlooking the crucial importance of technology development and management, many countries are relinquishing the opportunities of tapping into second order benefits. These benefits, in turn, are becoming more concentrated among a group of economies that are home to the “digital commodity producer” firms.
Emerging economies need to formulate policies with the ambitious goal of reaping second order benefits. Policies targeted at enhancing participation in e-commerce and digital platforms, for example, can only boost a country's long-term competitiveness if there is a clear understanding that an extra effort will be needed to push the economy towards a position of digital technology development and management.
Different initiatives therefore need to be blended under a single national strategy aimed at preparing the economy to go beyond the adoption and use of such technologies. This is not an easy task, especially because some of the policies designed to seize first order benefits may not initially be aligned with reaching second order benefits.
Countries should pursue a bold agenda focused on knowledge, one that goes well beyond infrastructure and takes into account issues such as the generation, storage, processing, and transfer of data – both within and across national boundaries; data privacy and security; taxation in the digital economy; and non-discrimination and access. This bold policy agenda should reflect the fundamental changes that are occurring in the forms of production; the importance of intangible capital; technology and branding; and the production of goods with built-in services in an increasingly digital environment.
To highlight the importance of this cross-cutting approach, the strategy for digital development should have a symbiotic relationship with policies in the areas of trade, education, technology, innovation, services, and competition. Trade policy, for example, has increasingly included elements that go beyond traditional trade in goods, such as services, e-commerce, data flows, intellectual property, and public procurement.
There is also a need to bring competition policies to the digital age, so that they are up to the challenge of restraining oligopoly and monopoly positions and protecting consumer interests. If the benefits of the digital economy mostly accrue to technology and platform developers and managers, there should be clear space for policy implementation and regulation.
The coordination of these policies at a high political level – for subsequent translation into action – can determine the success of future programmes designed to enable the development of platforms.
As we are dealing with new trends, latecomer countries will need to have proactive, flexible, and smart form of engagement in order to learn how to navigate in those waters and derive benefits. To this end, policymakers will have to coordinate policies from the start, experiment, monitor, evaluate, be pragmatic, and collaborative.
Addressing digital divides is key to enable countries to reap and share the benefits of digital transformation. However, the asymmetric distribution of first and second order benefits within and between countries can increase income inequality, thereby generating additional obstacles to the implementation of the above policies and the promotion of income convergence.
Finally, as several economic development experiences suggest, this strategy will probably be more successful if government, business, and workers combine their interests and cooperate in policy design and implementation.
Much can be done to develop and expand the role of the digital economy in emerging economies. The more this venture is anchored in the fundamental principles of wealth creation in the 21st century, the greater its probable success.
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