Digitalization and market power

Article by Thieß Petersen, Senior Advisor, Global Economic Dynamics Project, Bertelsmann Stiftung, Germany and Lecturer, European University Viadrina

The use of digital technologies increases market transparency for consumers and enlarges the relevant market. This strengthens their negotiating position vis-à-vis companies. However, there exists also the risk that large technology companies will develop into global monopolies that exploit their market power at the expense of consumers.

Digitalization reduces the market power of local companies

On the one hand, digitalization can reduce the market power of individual providers. If only one supplier of electrical appliances operates a store within a thirty miles radius in a rural region, she can charge mark-ups for her products and thus increase her profits. However, if there are internet-based search engines and online platforms, interested customers can search for offers of equal quality and take advantage of price differences.

Digital technologies also reduce the costs associated with delivering a product purchased online and handling payment. Consumers can therefore significantly expand the market that is relevant to them. For example, a local electronics retailer loses market power and has to adjust her price to the national or even worldwide market price.

A further weakening of the market power of local providers results from the possibility that private individuals offer goods and services on digital platforms. If they appear on the market as additional suppliers, this has an impact on the established commercial providers. For them, the additional supply represents competition that forces them to reduce their prices.

Digitalization can result in global monopolies

On the other hand, the characteristics of digital goods can have the effect that only one provider dominates a market in the long-term, thus creating a monopoly. There are two central reasons for this.

(1) The development of digital infrastructures or new computer programs involves high fixed costs. Once the computer program exists, the duplication and distribution of further copies of the program involves very low additional costs. With this cost structure, the increase in production volume results in decreasing costs per unit. This means that the supplier who produces the largest quantity has the lowest costs per unit and can therefore demand the lowest price. Therefore, only one supplier survives on the market.

(2) Digital platforms often rely on network effects. This means: The benefit for the consumer depends on the size of the network. The more participants there are in a social network or an online platform such as Airbnb, the more attractive it is for people to join the network. In the end, the company that has the most participants wins – and displaces all other providers

Disadvantages of monopolies for consumers

Monopolies have a number of economic disadvantages for consumers, other companies, and employees.

First, monopolists demand higher prices because they have no competition. For consumers, this means a loss of purchasing power, which reduces the opportunities for consumption.

Secondly, a monopolist also has market power as a buyer, with which it can lower the prices of inputs and wages. There are indications that the emergence of so-called superstar companies such as Google, Apple, Amazon, Facebook, and Uber is putting pressure on wages or on wage increases.

Thirdly, for a monopolist without competition, there is no need to improve the quality of its products and lower the prices of its products through technological progress. The central advantage of a market economy for consumers – an improved product offering at lower prices – is thus not realized.

Fourthly, monopoly profits imply high financial resources. This financial power can be used to buy up potential competitors at an early stage and thus restrict competition. The financial resources can also be used to acquire companies and enter entirely new markets that are not part of the actual business area.

Finally, economic power can become a political power. Monopolies are important economic actors as employers and taxpayers. This increases the probability that political decision-makers will listen to these companies and their partial interests. This can result in political decisions that are at the expense of consumers, employees, and small businesses.

Conclusion and outlook

The increased use of digital technologies offers a number of economic advantages. These include, above all, an improved supply of goods and services. As digitalization progresses, people are being offered a greater variety of products, can consume a larger quantity of products, and have to pay lower prices. Greater market transparency strengthens the position of consumers vis-à-vis companies and reduces prices further.

The economic risks of digitalization include monopolization tendencies, which can be at the expense of consumers and employees. A key economic policy challenge is therefore to use competition policy instruments to prevent the exploitation of market power so that the price-reducing and welfare-enhancing effects of increasing digitization can be realized.


Note: This is a shortened and revised version of the article “Digitalization of the Global Economy: Monopolies, Personalized Prices and Fake Valuations“, which was published on the project page of “Global Economic Dynamics” on October 30, 2020.

The Luddite fallacy: Is it time to reconsider it?

Article by Vihang Jumle, Data Analyst

20 December, 1922 marked an important transition in the history of employment. As the winter mist settled on the dawn-lit streets of Brooklyn Heights in New York, the city and its many residents stood wide awake to witness the dramatic and historic end of natural fire engines. As the clamour of hooves and neighs of Engine Company 205’s horses broke the morning silence and marched to the ultimate ceremony at Brooklyn Borough Hall, the world embraced the motorised car and all its possibilities. With a long stint of over 50 years, horses, which until that day were used to pull the fire engines, lost their jobs to technology. Unfortunately, so did numerous horsemen, stable workers, and trainers.

Similarly, the 1990s witnessed bank tellers lose their jobs to ATMs. During different periods of history, factory workers, farmworkers, and craftsmen too, met with the same fate. Technology, it was feared during all these periods, was going to automate all the jobs. Possibilities of such havoc exist today too. Oxford University researchers, Carl Benedikt Frey and Michael Osborne, in 2013 concluded that 47 percent of 702 different American jobs could be automated in the next two decades. A similar study was conducted by the OECD, taking a different approach than the Oxford researchers, which also spoke about high rates of job automation.

However, on the contrary, the world has only added more jobs over time with most displaced jobs circling back into the system. Do people still have reasons to be worried about the adverse effects of rising automation?

Technological unemployment is not unprecedented. It is perhaps as old as the invention of the wheel. Aristotle in 350 B.C.E spoke about how machines would one day eliminate the need for human labour. The eighteenth-century population, amidst mass unemployment, was rather pessimistic about machines taking over jobs. Keynes in the 1930s coined the term “technological unemployment” to denote job losses caused due to automation and argued that the short phase of unemployment was merely a “temporary phase of adjustment” before the jobs circle back into the economy.

It is accepted wisdom that any technological innovation causes only short-term unemployment, with negative implications being minimal in the long-term. This wisdom exposes the “Luddite fallacy” — a term used to point out that technological innovation causes no long-term negative effect on employment. Economists like Jacob Mincer and Stephan Danninger, have relied on the “compensation theory” to justify the minimal to none negative effects of technological innovation on employment in the long-term.

Here’s how it works: automation leads to an increase in productivity since machinery produces goods at a lower price and at a faster pace. Since a product’s demand generally tends to rise only little over the short term, workers are laid off as machines take up their share of work. Decreased product prices, allow consumers to spend their surplus money in different markets, creating newer demands elsewhere. Similarly, the costs saved by business owners by laying off workers allows them to reinvest money into new ventures, creating its own new demand for labour. This in the long run compensates for the temporary loss in jobs since labourers tend to get re-employed to meet these newly created demands.

For instance, after robotic arms replace labourers in assembly lines, newer demand for labourers prop up in industries that create robotic arms, hence re-generating the lost jobs. This reasoning became the foundation of “compensation theory” and other frameworks designed by classical economists who argued that construction, maintenance, and development of machines required to do the automated work creates its own demand for labour. Traditionally this did hold true.

However, recent spikes in the pace of automation have raised red flags over the validity of compensatory mechanisms. It is less known if the compensation effect can make up for the piling structural unemployment caused due to rapid and disruptive automation.

Coal mine workers, especially those engaged in drilling, digging, etcetera, were amongst the first to lose their jobs to automation brought in by heavy machines. The compensation effect enabled laid-off workers to find new jobs in manufacturing industries and factories after a short phase of unemployment. It is however unclear if all lost jobs will manage to circle back into the economy due to rapid automation going forward.

Workers may be laid off more often since jobs are likely to be automated much faster than before. This implies that unemployed workers will need to develop skills for new jobs frequently and quickly. And assuming not all workers will be able to do so, the pool of unemployed workers will continue to grow larger. This situation appears more pessimistic if we account for rising levels of job complexity. Coal mine workers could easily adjust to assembly line jobs due to the similarity in functions: a combination of human strength and following a set instructions.

However, such repetitive jobs in the future will remain scarce because they may have already been automated leaving only high-skill specialized jobs as available options for low-skilled unemployed workers. This may compel them to upgrade their skills in short spans. Some high-skill level jobs that demand cognitive power, such as technicians, nurses, etcetera also require work certifications which may add more hurdles. Not to forget that available high-skill jobs created as compensation too stand the risk of being automated before low-skilled unemployed workers manage to upgrade their skills.

Much like other public policy issues, this problem too tends to have a larger impact on less privileged workers. It is so because repetitive jobs — that follow a set of instruction — stand a high risk of automation. These generally include middle-class blue-collar jobs that employ assembly line workers, machine operators, etcetera. Categories on either ends of the skill spectrum (low skill jobs like house cleaning and security and high skill jobs like in engineering and healthcare) have in fact gained more jobs whereas the middle-class blue collar jobs have shrunk due to rapid automation over the last couple decades.

From the 1980s to 2010s, the global share of workers in middle-income class has shrunk from 65.9 percent to 58.4 percent, whereas the share of workers in the lower-income class has risen from 26.1 percent to 33.5 percent in the same period. This trend is likely to continue due to the nature of blue-collar jobs, and perhaps, governments could play their role by slowing down automation in this sector and focus more on skill development.

Similar policy level moves are a separate discussion altogether; the objective here is to highlight that compensation theories likely need to be reworked to account for the recent high pace of automation. Perhaps we need to acknowledge that people do have valid reasons to worry about their jobs going permanently if conversations to regulate automation do not gain momentum.


Note: The views expressed in this article are those of the author and not of any affiliated organization.

How the COVID-19 pandemic will boost digitalization

Article By Thieß Petersen, Senior Advisor, Global Economic Dynamics Project, Bertelsmann Stiftung, Germany and Lecturer, European University Viadrina

The corona crisis has the world in its grip. The extent of the social upheavals and the long-term consequences of this pandemic are not yet foreseeable. However, there is some evidence that it will further accelerate the use of digital technologies. The associated economic transition needs socio-political support.

The economic aspects of COVID-19

The global economic crisis triggered by the spread of the coronavirus COVID-19 is not only an economic demand crisis, but at the same time, a supply crisis.

Previous global economic slumps — such as the global economic crisis in 1929 and the recession following the Lehman bankruptcy in 2008 — were the result of bursting speculative bubbles. The resulting uncertainty abruptly reduced demand for consumer and capital goods. This caused a massive economic slump (Petersen 2018). However, production capacities were not affected: Companies could have produced if there had been a demand for their products.

The current situation is fundamentally different. A rapidly spreading infectious disease initially has a dampening effect on demand. For fear of infection, people avoid transactions. They refrain from visiting restaurants, cinemas, theatres, sports events and cancel holiday trips. The drop in demand is particularly high when state authorities prohibit such activities for reasons of prevention.

In addition, a pandemic reduces the production potential of an economy. If employees are absent because they are ill or are not allowed to appear at work for fear of infection, the production capacities of companies are reduced. In the worst case, companies are completely closed down. Thus, a supply crisis is added to the prevalent demand crisis (Petersen 2020).

These real economic effects change macroeconomic developments and entrepreneurial decisions — both in the short and in the medium term.

Short-term boost in digitalization by COVID-19

The decline in consumer demand caused by COVID-19 can be compensated, at least in some areas, by switching to online trading. Online purchases replace purchases in stationary trade. The same applies to delivery services that replace restaurant visits.

The trend towards greater use of these types of consumption is already becoming clear. In mid-March, Amazon announced the hiring of 100,000 additional employees in the USA to handle the higher amount of online orders in the wake of the corona crisis (Mattioli 2020).

These developments could permanently change the structure of retail trade. If the closure of stationary stores continues, it will unavoidably lead to high losses for them and could cause bankruptcy. As a result, many stationary shops could completely disappear and be replaced by large online providers.

Medium-term boost in digitalization by COVID-19

A tool that is already being intensively implemented to reduce health-related absenteeism among employees is the use of home office. This decreases the risk of infection and prevents the absence of employees who do not want to enter the company for fear of infection. In the future, companies are likely to intensify this form of working — at least in those areas where the use of home office is possible — in order to be better prepared for a future pandemic.

Another reaction to the experience of the corona pandemic is that companies are increasingly using machines, robots and other digital technologies in the production of goods and services. This amplified tendency towards automation replaces human labour and thus reduces the dependence on labour in the production process.

The increased use of digital technologies instead of human labour requires extensive investments. However, it is yet not clear to what extent the private sector will be able to finance such investments after the end of the corona crisis.

New social conflict lines

The technological answers to the question of how companies or entire economies can better prepare for future pandemics show that the response options are unequally distributed within the economy —

(1) While manufacturers of physical goods can fall back on online trade, this is not possible with many forms of so-called social consumption — above all, tourism. The suppliers of such social consumption activities (i.e., not only the owners of the businesses but also the people employed there) bear a greater risk of losing income in the event of a future pandemic.

(2) The opportunities to carry out professional activities in one’s own home are also unequally distributed within society. Especially in the area of personal services, this form of work is simply not possible.

(3) Not all companies will have the financial scope to achieve a greater degree of automation and digitalization. This is likely to be particularly true for small and medium-sized enterprises, which have less access to credit than large companies.

The digitalization accelerated by COVID-19 and the associated economic transition can also lead to tensions between economies —

(1) The increased use of capital and technology means that many emerging and developing countries are losing their most important international competitive advantage — cheap labour. As a result, the poorest countries may remain disconnected from global economic growth.

(2) Many industrialized countries will consider whether they will produce particularly important inputs and final products domestically (especially in the medical sector, but not only there) in order to reduce their dependence on imports.

The trend towards so-called reshoring (Petersen 2019) is likely to accelerate: Industrialized countries will relocate production steps that they originally had shifted to low-wage countries. For these low-wage countries, reshoring leads to losses in jobs and income.

Outlook

The economic impact of a pandemic will cause many companies to adapt their medium and long-term strategies to make greater use of digital technologies. The associated economic transition implies economic disadvantages for certain groups of people and regions.

However, we should not prevent this technological development because it improves resilience in situation of crisis. The boost in digitalization caused by COVID-19 should be accompanied by appropriate social policies. Both, within and between countries, we need mechanisms that allow the potential losers of the economic transition to get a share of the benefits of digitalization. This in itself is ethical and fair.

Furthermore, the support of those losing employment and income is also in the interest of those who are financing this support. Without compensations, social tensions and political polarisation will increase — both within and between countries. This hampers the national and international division of labour, and is thus at everyone’s expense.

References

Mattioli, D. (2020). Amazon to Hire 100,000 Warehouse and Delivery Workers Amid Coronavirus Shutdowns. The Wall Street Journal.

Petersen, T. (2011).10 Years after Lehman – Does another Economic Crisis loom? (Part 1). Global Economic Dynamics. Bertelsmann Stiftung.

Petersen, T. (2020). What does the coronavirus outbreak mean for the global economy? Global Economic Dynamics. Bertelsmann Stiftung.

Petersen, T. (2019). What Is the Impact of Reshoring? Global Economic Dynamics. Bertelsmann Stiftung.


Note: This article is a reworked and modified version of a post published in German on the blog Zentrum Liberal Moderne: That post can be accessed here.

How AI and Big Data could increase the international division of labour in the future — and partial interests might prevent this

Article By Thieß Petersen, Senior Advisor, Global Economic Dynamics Project, Bertelsmann Stiftung, Germany and Lecturer, European University Viadrina

Artificial intelligence (AI), big data and other digital technologies have the potential to reduce the costs of the international division of labour in the future. The resulting merging of markets would improve the supply of goods and services to people. However, some companies and their employees may lose international competitiveness. This increases the danger that governments will take protectionist measures to shelter these companies.

AI and Big Data reduce costs of international division of labour

In the context of digital change, technological developments are in sight which could have far-reaching consequences for the international division of labour. The renowned economist Hal Varian, for example, is convinced that speech recognition and translation programs will make real-time verbal language translation possible in the near future. This would eliminate language barriers in international trade and significantly reduce the costs of global trade. The result would be an increase in cross-border trade and the underlying international division of labour (Varian 2016, p. 8; Melitz and Toubal 2019).

Cost reductions induced by digitalization can also be expected for other trading costs. Examples include more efficient coordination of logistics to overcome national borders and to distribute products in the various foreign markets, lower search costs to identify suitable customers abroad, and software solutions for processing digitally available customs documents. (Bartholomae 2018, p. 9). These reductions in the costs of international trade suggest an expansion of the international division of labour.

International trade improves material well-being of citizens

Intensifying the international division of labour and the associated international trade improves the supply of goods to citizens through at least three channels (Petersen 2016):

(1) International division of labour means that each country concentrates on manufacturing the products for which it has the greatest cost advantages. For consumers, this means that they can buy cheaper goods from abroad. The purchasing power of consumers increases. This allows the consumption of a larger quantity of goods, i.e., an increase in material prosperity.

(2) Domestic suppliers are losing market power due to additional competition from abroad. Existing profit margins must be reduced. For consumers, this means lower prices, i.e., a further increase in their purchasing power.

(3) Finally, the additional competition from abroad accelerates the structural change of an economy. Less competitive companies disappear from the market. The factors of production used there can now migrate to future-oriented industries. This process of “creative destruction” increases the productivity of the entire economy (Andersson, Braunerhjelm and Thulin 2011). This, too, is a positive development for consumers because the prices of goods are falling.

All in all, the international division of labour induced by AI and digital technologies is a positive development for people in their role as consumers: they can buy more goods and services at lower prices.

International trade means loss of income for some citizens

In their role as producers, i.e., as capital owners or as employees — it can happen, however, that some individuals suffer economic disadvantages as a result of a stronger global division of labour resulting from digitalization. The owners and employees of companies that are no longer competitive with the new providers from abroad have to suffer income losses.

In highly developed economies such as the United States, Germany, and the United Kingdom, this currently in particular affects industries competing with providers from low-wage countries. Even in the market for industrially produced goods, the advanced economies are coming under growing pressure: here they are increasingly losing their price advantages to emerging markets, especially China.

Conflicts of interest between consumers and producers

In principle, AI and digital technologies therefore have the potential to promote the economic advantages of the international division of labour and thus increase people’s material well-being. However, an intensification of the cross-border division of labour as a result of digitalization means a loss of income for individual producers. This is why there is a great likelihood that these individuals will advocate protectionist measures — a concern that contradicts the interests of consumers.

Theoretical considerations and historical experience suggest that political decision-makers are more likely to listen to the interests of the endangered domestic suppliers, i.e., the capital owners and employees — and resort to protectionist measures (Petersen 2019). In this way, however, society as a whole is foregoing increases in material prosperity.

Whether the digitalization-related reduction in the costs of cross-border trade actually leads to an intensification of the international division of labour is therefore not guaranteed.

What needs to be done?

An intensification of the international division of labour as a result of digitalization basically leads to an increase in the material prosperity of society as a whole. At the same time, however, there are also groups of people within a country who suffer income losses. In order for digital progress to benefit as many citizens as possible, the resulting increases in income should be distributed in such a way that the negatively affected groups of people also gain from them. This recommendation is not only for reasons of fairness (Wright and Schultz 2018). A broad diversification of digitalization-induced income growth is also necessary so that the social acceptance of digital progress is not lost.

Many policy areas are called upon to take appropriate measures — improving social security mechanisms and restructuring the entire education system are some examples to prepare the ground for sustainable AI futures. Because digitalization and international division of labour increase the material prosperity of the economies involved, the winners of digitalization and international division of labour in a country can compensate the losers — at least in principle — and still improve their own income situation.

In general, the digital transformation of the economy and society requires social protection. In this way, people can obtain the necessary security they need to help shape digital change instead of preventing it. Without this security, a blockade attitude on the part of many citizens can be expected.

References

Andersson, M., P. Braunerhjelm and P. Thulin (2011). Creative Destruction and Productivity: Entrepreneurship by type, sector and sequence. Swedish Entrepreneurship Forum Working Paper.

Bartholomae, F. W. (2018). Economic Impact of Digitization on International Competition and the International Division of Labor. Volkswirtschaftliche Diskussionsbeiträge, Universität der Bundeswehr München.

Melitz, J., and F. Toubal (2019). The potential impact of machine translation on foreign trade – caution, please. VoxEU.

Petersen, T. (2019). Davos Discussion – The Paradox of Protectionist Policies. Global Economic Dynamics. Bertelsmann Stiftung.

Petersen, T. (2016). GED Explains: Why More Foreign Trade Means More Growth. Global Economic Dynamics. Bertelsmann Stiftung.

Varian, H. R. (2016). Intelligent Technology. Finance and Development 53(3): 6 – 9.

Wright, S. A., and A. E. Schultz (2018). The rising tide of artificial intelligence and business automation: Developing an ethical framework. Business Horizons 61: 823 – 832.