From digital trade wars to governance solutions: The G20 and the digitally enabled economy

28 August 2018
  • The progressive shift of economic activity into the digital realm promises to create unprecedented incentives for strategic trade and investment policies.
  • These incentives, in turn, drive already escalating frictions within the trading system.
  • The G20 brings together the main protagonists and can help by maintaining a constructive dialogue and brokering cooperative solutions.

 

With the digital transformation, an increasing share of economic activity is accounted for by digital or digitally enabled modes. Digital disruption is being felt pervasively: digital versions of products or services compete with physically embodied versions; digital distribution and facilitation business models compete with traditional models; and entirely new modes of trade have been enabled, including trade between households mediated by digital platforms, and non-monetised barter exchange of digital services in return for the value of data as an asset.

With datafication – when virtually every aspect of economic and social interaction is recorded and stored as data – a new type of economy is taking shape, evolving from the knowledge-based economy that characterised the advanced economies from the 1980s.

In this data-driven economy, which is discernible in at least nascent form in the period since the great recession of 2008-2009, data plays various fundamental roles. It is the medium for commercial transactions in digital space (including coordination of intra- and inter-firm international production networks), the facilitator for digitally enabled trade, the essential capital stock for data-driven business models, and the soft infrastructure of a digitised world.

The different roles of data come with different policy imperatives: a requirement for free flow to facilitate cross-border commerce in digital and digitally enabled forms; compensation for its asset value in trade; and security for the economy’s digital infrastructure. The reconciliation of these potentially inconsistent objectives is a conceptual and political challenge of the first order.

The digital governance challenge

Layered on this policy architecture challenge are the myriad regulatory concerns raised by the digital transformation. These include preservation of personal privacy, integrity of democratic processes, maintaining the tax base to fund public goods, and economic regulation to address market failure. Even the very definition of national production is at issue, given the ability to locate intangible capital anywhere internationally at the discretion of companies (e.g. to take advantage of low corporate tax regimes).

This was highlighted by the 2015 accounting “surge” in Ireland’s gross domestic product to reflect returns to intellectual property following the shift by a number of large multinational firms of their tax domicile to Ireland. A similar issue is raised by Estonia’s e-residency programme, which enables entrepreneurs anywhere in the world to set up and run a location-independent business on Estonia’s business governance platform.

Importantly for the international community, the data-driven economy promises to serve up market failure in abundance. This reflects, inter alia:

  • powerful economies of scale and scope, and network externalities in the digital sphere, which give rise to superstar firms;
  • pervasive information asymmetries, inherent in the training of artificial intelligence (AI) on big data, between human and machine, between companies that have proprietary data and AI capability and those without, and between countries due to the digital divide;
  • the production of what might be termed “machine knowledge capital,” which complements and competes with human capital just as robots complement and compete with unskilled labour.

To underscore the significance of the last point, whereas robots are expensive and take time to build and deploy, machine knowledge capital can be expanded at near zero marginal cost and distributed globally with near frictionless ease and thus features the “replicator economics” of Star Trek. The deployment of machine knowledge capital on a massive scale promises to generate similar effects on returns to human capital in the advanced economies as the entry of China and India into the global division of labour and the robotisation of routine production had on blue-collar jobs and wages. By making robots more effective, it will also intensify the impacts of robotisation on unskilled labour

But the effects will be more pronounced and felt much more rapidly due to the industrialisation of learning itself. Returns will flow to owners of machine knowledge capital, which will likely constitute the most valuable rent-generating assets of the data-driven economy, enabling the concentrated capture of global rents flowing to this new factor of production.

The combination of these sources of market failure creates powerful inducements for strategic trade and investment policy, which in turn inevitably gives rise to international friction.

This is already very much in evidence over, for example, China’s ambition to achieve strategic advantage in AI and other advanced technology spheres by 2025, and the adoption by the United States of countermeasures on trade and its application of new screening for foreign direct investment (FDI) into its national technology sectors. Other economies are throwing their hats into the ring, including smaller open economies that have an interest in gaining a foothold in the data-driven economy, while at the same safeguarding the integrity of their socio-economic systems.

The digital trade wars have begun, and there is a need for an institutional response to mediate and help identify the terms for a new sustainable trade bargain for the digitally enabled economy. The G20 is ideally situated to take up this challenge since it is small enough to be nimble, yet counts in its membership all the major economies driving the digital transformation.

Towards a G20 agenda for the digitally enabled economy

Measuring the digital economy: G20 priorities

The G20 has engaged the digital economy through two streams:

  • the Digital Economy Task Force (DETF), which is addressing the issues related to measuring the digital economy, the implications of the data-driven economy (“Economy 4.0”), digital infrastructure, digital government, and issues of inclusiveness;
  • the Trade and Investment Working Group (TIWG), which is addressing the trade and investment linkages, with a focus on small and medium-sized enterprise engagement.

The DETF work on measuring the digital economy should give a high priority to measuring the value of data. Statistical agencies, including Statistics Canada and the US Bureau of Economic Analysis, are engaged on integrating data as an asset into economic accounts, developing typologies that sort out what has value from what does not, assigning ownership and location, developing techniques for measuring the value of data as an intangible asset, and identifying the role of data in growth and productivity. The DETF would be an ideal forum to invite presentations and discuss and stimulate parallel work on this on a G20-wide basis. Understanding the value of data is essential to enabling informed policymaking on issues related to the flow of data across borders.

Second, building on this work, the DETF should consider the question of alternative architectures for reconciling the needs for cross-border data flows for trade purposes, capturing value of cross-border flows for trade negotiation purposes, and the need to secure data in its role as economic infrastructure. For example, the 2016 Trans-Pacific Partnership banned data localisation and committed the parties to the free flow of data across borders, albeit with allowance for restrictions necessary to achieve a legitimate public policy objective. Given the role of data in developing AI and machine knowledge capital, “free” cannot be understood as synonymous with “uncompensated.” Moreover, there is much work to do in elaborating reasonable interpretations of the “legitimate public policy objective” carve-out for data localisation.

Third, the DETF could usefully take up the issue of how fast machine knowledge capital is being created and deployed, which sectors it is impacting initially, which sectors are actively exploring the uses of data for this purpose, how machine knowledge capital could be rapidly deployed in developing countries to alleviate skills gaps, and how to fairly share the returns to machine knowledge capital, given that it will be developed on data generated by whole populations (see here and here for examples on data as a public good).

For its part, the TIWG could usefully build on the preliminary work done for the G20 on the typology of digital and digitally enabled trade flows, refining typologies to facilitate the mapping of trade restrictions and developing approaches to ensuring neutrality of taxation and market access across technological platforms, and mobilising the work in identifying and classifying barriers to digital trade.

Further, the TIWG could usefully seek to extend recent work in constructing digital trade balances to provide a fuller picture of bilateral trade relations in the digital age. Key elements to factor into flows would be the implied value of data acquired by platform companies in exchange for “free” internet services, and the misdirection of flows of payments internationally due to tax strategies of the major internet corporations (e.g. licence fees and royalties flowing to Ireland but ultimately destined for beneficial owners elsewhere, and other similar examples), integrating the work done by the Organisation for Economic Co-operation and Development in this area under its base erosion and profit shifting (BEPS) programme.

Finally, the TIWG could also address the possible need for mutual accommodation, especially in labour market adjustment, to proliferation of machine knowledge capital – for example, a peace clause on policy measures designed to ease pressures on labour markets that affect international trade.

Revisiting foreign direct investment policy

An emerging flashpoint for the digital economy is the role of FDI into technology sectors. In the industrial economy, FDI was generally understood as a source of an inward flow of technology and advanced management practices, reflecting the fact that firms capable of investing abroad tend to be the dominant firms in their home base. Foreign-invested firms also tend to undertake more research and development than purely domestic firms, even if the bulk of it tends to be done by multinational firms at headquarters.

In the technology sectors, however, investment – especially of the mergers and acquisition (M&A) type – typically aims to acquire and often to expatriate knowledge assets. Even locating research facilities in research hubs has the prime intent of extracting knowledge rather than introducing it into the hub.

This is leading authorities to apply a new public policy filter for screening inward FDI, particularly in instances where the inward FDI is from a state-owned enterprise or is acquiring technology that might have security implications, but also more broadly given the incentives for international rent capture through strategic trade and investment policies in the knowledge-based and data-driven economy.

Additional relevant and conflicting policy considerations for a G20 review of FDI policy include the following.

  • Extraction of knowledge capital from a research hub diminishes its dynamism by reducing knowledge spillovers within the hub. Based on conventional economic arguments regarding externalities, public intervention would be warranted where the appropriable private returns to an individual start-up from selling to a foreign firm do not reflect the externalities that the start-up firm’s presence in a given innovation location generates for the location. In other words, there is a public interest in the transaction that goes beyond the private interest.
  • For emerging markets, economic development is arguably almost entirely about technology acquisition. Outward, technology-seeking investment drives overall economic development that in turn drives demand for other goods and services. In a nutshell, the growth of China’s imports of goods and services ranging from soybeans to autos (and the growth of payments for technology) was contingent on China moving towards the technology frontier. Other developing countries that have not had China’s singular focus on technology acquisition have not matched China’s development trajectory.

An open discussion in the G20 about these tensions with the objective of narrowing and sharpening the grounds for intervention while acknowledging the differences in the dynamics of FDI in technology versus traditional industrial sectors would help contain the potential conflict.

Systemic Issues

Three systemic issues can be singled out as warranting attention in a G20 dialogue on the digital economy.

  • Competition policy: the tendency in the data-driven economy towards concentration at a global level implies more frictions globally over restrictive commercial practices by companies with market power and cross-border M&As that create issues for third countries. For the G20, a useful contribution would be in terms of identifying modalities to provide competitive access to data for firms in smaller economies and in developing economies in order to alleviate the problem of asymmetric information that is endemic in the data-driven world to promote competition in a dynamic sense.
  • Regulation of digital platforms: the role of platforms as utilities in the digital sphere has led to calls to regulate them accordingly in order to allow the efficiencies that flow from scale under natural monopoly conditions.
  • The role of the state in investment: the acceleration of the pace of change in the data-driven economy necessarily shortens the time horizon over which investment needs to be recouped. In turn, this implies that private investment will hesitate on a range of risks that previously would have found ready and willing investors, which will place a commensurately greater onus on public sector risk-taking.

Modalities for cooperation

The progressive shift of economic activity into the digital realm poses a wide range of conceptual issues and creates perhaps unprecedented incentives for strategic trade and investment policies, which are already escalating frictions in international trade and investment.

While evolving rapidly, the governance of data and the digital economy is not yet “treaty ready,” and a robust architecture for the data-driven economy has yet to be established.

The G20 brings together the main protagonists in this unfolding drama and can make a valuable contribution to international governance in this area by maintaining a constructive dialogue focused on narrowing the scope for conflict and brokering cooperative solutions through transparency.

 

This article is extracted from the forthcoming ICTSD compilation on How the G20 Can Reshape the Global Trade System. The compilation is the third in the series (see the first and second) and will be released in October 2018.

Dan Ciuriak is Director and Principal at Ciuriak Consulting Inc.