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7.1 Digital Platforms Are Prone to Market Concentration and Dominance
BOX 7.1 Digital Platforms Are Prone to Market Concentration and Dominance
Three key features of the digital economy create a tendency for market concentration. The first is returns to scale, driven largely by technologies that have led to a rapid and steep decline in the costs of data storage, computation, and transmission. The second feature is network externalities, which arise from the fact that the convenience (value) of using a product or service increases with the number of users that adopt it. The third feature is the intensive use and accumulation of personal data. Digital technologies allow companies to collect, store, and use large amounts of data that in turn lead to continuous improvements in business intelligence and more profitability.
These features erect barriers to entry and make certain digital markets, such as digital platform markets, prone to market tipping: that is, once a firm gains an initial advantage, it keeps building on that advantage at the expense of its competitors. This in turn creates conditions for a winner-take-most economy, leading to concentration of market power and wealth in a small number of global “big tech” firms and individuals. Although these features are not unique to the digital sectors, they tend to be much more relevant than in most traditional activities.
There is also evidence that firms based in high-income countries have been using anticompetitive practices in overseas markets to gain market dominance. An analysis of publicly available information on 103 finalized antitrust cases around the world, as of January 2020, reveals that most cases concerning abuse of dominance and anticompetitive agreements have been filed in developing countries against firms headquartered abroad. This pattern calls for international cooperation to prevent such abuse, such as a coordinated effort on digital taxes, data interoperability policies, and adoption of standards to allow data flows across firms, industries, and borders so firms in developing countries also have a fair chance to scale.
Source: Zhu et al., forthcoming.
3. Ensure an Open Trade Regime that Supports Access to External Knowledge and Technology
As shown in the previous chapter, participation in international markets and global value chains facilitates the adoption of technologies. While trade and investment policies appear to be beyond the realm of technology policies, they are in fact intertwined. For example, high import tariffs or nontariff barriers on equipment, restrictions on hiring foreign engineers and managers, or restrictions on investors and technology licensing can be critical barriers to technology adoption. Maloney (2002) shows how in addition to lack of investments in knowledge institutions, inward policies focusing on import substitution played a key role in impeding economic growth in Latin American countries. Ensuring access to external knowledge and the diffusion of technologies is key, especially for most developing countries that adopt existing technologies.
4. Facilitate Access to Finance for Technology Upgrading
Financial market imperfections related to information asymmetries and lack of competition in the financial sector make the financing of technology upgrading in developing countries difficult and costly. In many developing countries it is unusual for commercial banks to finance technology upgrading projects. Firms must make these investments with their own resources, which considerably limits their capacity to invest, or they must deal with very high collateral requirements or very high interest rates, which make investing in new technologies unprofitable.
Public agencies need to work with the financial sector to stimulate this type of lending by providing funds that reduce potential liquidity problems and lower the cost of finance, or by providing credit guarantees. In addition, public agencies can support the use of expert consultants and technology mentors to strengthen firms’ loan applications. More important, publicly backed finance programs can provide a demonstration effect with commercial banks to show how to screen technology upgrading projects and minimize risks while financing this type of project.
5. Provide Information and Build Institutions to Address Coordination Failures
Flows of specialized information are particularly important for small businesses, which tend to be less informed about the latest technologies available in the market. While it should be in their private interest to join forces to obtain this information, private firms face a common coordination failure that pushes them to act independently. As a result, there is a role for public policy to facilitate information and information flows. However, public institutions are not always best placed to provide this type of specialized information. Public-private partnerships with private sector organizations should be prioritized to ensure information flows. Filling this information gap is important to minimize entrepreneurs’ uncertainty about adoption. No information flow can guarantee the returns to investing in such technology, but better information can help entrepreneurs assess these returns and make more informed decisions.
Perhaps the most important role played by public agencies to support technology upgrading is addressing coordination failures. A firm’s performance depends on the actions of other firms. Market failures associated with economies of scale, spillovers, or nonexcludability (where other firms can enjoy the benefits without paying for knowledge) in the provisions of these inputs and services can lead to multiple equilibria, which in turn require coordination to move from low to a high equilibrium (RodríguezClare 2006). Moreover, information frictions, irrational behavior, or path dependency, among other factors, can lead also to a low equilibrium (Hoff 2000). Coordination to deal with such failures is not always possible in the market.
Consider the fact that many firms do not upgrade their technologies because of the lack of information or an adequate skilled labor force, as described in chapter 6.
A market solution is to coordinate with other firms in the industry so this information and training are provided. However, industry associations sometimes respond to the rent-seeking behavior of some of their more powerful associates, and participation in those associations is often low, especially among smaller firms. Hoff (2000) provides some examples of coordination failures in different contexts of developing countries. The important takeaway is that private agents may not necessarily coordinate to achieve a second-best outcome.
There is, therefore, a role for public policy in working with the private sector in aligning interests and ensuring an efficient provision of physical infrastructure, information, and skills. Perhaps the most important role is ensuring that firms of all sizes have good information about what technologies and what types of support from technology and digital solutions providers are available, as well as supporting adequate training for the labor force. This should be implemented jointly with private sector associations that know the sectors better. In addition, in countries where there is significant mistrust between the suppliers of technologies and digital solutions and local firms concerning the quality of services provided public agencies can play a role in matching supply and demand and ensuring some minimum quality standards that reduce information asymmetries.
This important coordination role does not guarantee that public agencies will be successful in achieving upgrading. Policy failure remains a risk (Besley and Case 1993), especially when public agencies want to take roles where they have no expertise or when interests diverge due to agency problems—when agents do not necessarily implement the interests of the agency. Public agencies need to take this risk seriously and make sure that there are checks and balances in the design of support policies (see the discussion later in this chapter).
Access to knowledge through business advisory and technology extension services is an important mechanism to build technological know-how and skills. They can enhance not only the absorption of new technologies but also the capacity for further learning (Cohen and Levinthal 1990). Although these services should not necessarily be provided by government agencies directly, many of them do so, and most important, there is significant room for improving failures related to asymmetric and incomplete information in these markets.
The potential market failure for knowledge has been well described by Arrow (1962) in what is known as Arrow’s information paradox, which applies broadly to the production of knowledge used by firms. The development and transfer of a technology involves the production and transfer of information that has three properties:
indivisibility, nonappropriability, and uncertainty. The main idea is that unless the information (such as business advice) is revealed, a potential buyer cannot accurately assess its value, but once the information is known, a buyer may have little incentive to pay the seller. These features present challenges to a well-functioning market for business and technology information. While these issues can be partially addressed by reputation mechanisms and contracts (Anton and Yao 2002), these instruments tend to be challenging, particularly for SMEs in developing countries. Yet evidence suggests potential productivity gains from these services (Bruhn, Karlan, and Schoar 2018). These programs can also be used to prepare firms interested in instruments that require further capabilities to benefit from them, such as export promotion.2 Thus, there is a role for policy in improving the provision of and markets for business advisory and technology extension services.
7. Enhance Awareness, Improving Targeting Mechanisms for Government Support and Strengthening Government Capabilities
Small firms are much less aware of government support programs and are also less likely to benefit from them, as shown in figure 7.1. FAT survey data reveal that only about 30 percent of small firms are aware of government support programs, compared to about 46 percent of large firms. A very low share of small firms benefits from existing support mechanisms. The gap between awareness and access is also larger in small firms. On average, the probability of a small business receiving public support for technology adoption is around 13 percent versus more than 35 percent for large firms. These results are associated with the fact that large firms have better access to information and have managers and business organizations that are better prepared, as described in chapter 6.
These results underscore the importance of disseminating information about government support programs to facilitate adoption, especially among SMEs. Smaller firms also tend to participate less in industry associations, and their entrepreneurs and managers have less time to participate in association activities. Thus, public agencies need to make more of an effort to reach out to these smaller firms.
Targeting mechanisms also need to be effective. Mistargeting occurs when public policies support unintended beneficiaries, either because they do not need the support or because they are not the targeted group. For example, during the COVID-19 pandemic, around 20 percent of firms that did not experience a drop in sales received support (figure 7.2).3 Among businesses whose sales dropped, large firms had a much larger probability of getting support. As seen in figure 7.1, larger firms also get more support for technology upgrading. This may be driven by barriers in terms of lack of information and fixed costs to apply, which are more binding for smaller firms, but also raise some potential political economy issues on how support may be implemented
