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Multilateral Cooperation and the Digital Economy – IMF F&D – International Monetary Fund


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Absent multilateral cooperation, the global digital economy could splinter,
and everyone would pay


Technology wars are becoming the new trade wars.


In the race to dominate the technologies of the future, the competition
between the United States and China has led to import and export bans of 5G
network technologies, semiconductors, social media platforms, and
data-based security applications across multiple countries. Countries are
also imposing restrictions on financial market access for foreign tech
firms deemed to be security risks. Trade liberalization in digital services
is giving way to increased restrictions (see chart).


From a classical economic perspective, this escalation makes little sense.
In traditional sectors, barriers to trade generally lower economic
well-being in all countries involved, as they prevent efficient
specialization and limit the variety of goods available.


In the digital era, however, leadership in emerging technologies bestows
outsize profits, global market shares, and the ability to set standards.
New services built on data, such as artificial intelligence, next
generation 5G networks and the internet of things, and quantum computing
have opened the way for new growth engines that promise to transform entire
industries and lift productivity. This trend toward an increasingly
digitalized and networked world has only been accelerated by the COVID-19
pandemic.


With a winner-takes-most dynamic—rooted in economies of scale and
scope—global technological leadership is highly prized. The IMF World Economic Outlook has shown that a small fraction of highly
productive and innovative firms has gained dominance and enjoyed large
profits over the past two decades (IMF 2019). The phenomenon spans sectors
and economies but is particularly acute in the digital sector.


Digitalization and connectivity have sped up the diffusion of knowledge while simultaneously bringing new security threats.


However, the race for leadership in digital technologies does not conform
to traditional borders and intellectual property protections. The networked
economy makes it possible to reach seamlessly across the world to collect
information and make decisions, enhancing economic efficiency. But it also
can allow thieves, saboteurs, and spies to reach back to steal, copy,
manipulate, or destroy. Digitalization and connectivity have sped up the
diffusion of knowledge while simultaneously bringing new security threats.

Toward a new tech order


Macroeconomists in general have treated security matters as largely
distinct from economic matters, except where conflict and crime dominate.
For the most part, they have taken the institutional underpinnings for
safeguarding property rights and military matters as separate from the
analysis of economic policy. But in cyberspace, there are no such
distinctions; no effective domestic norms or public institutions for
enforcing security, such as “e-police” or an “e-justice system”; and no
international mechanisms for de-escalation and maintaining peace.

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The interconnections of the digital era blur traditional distinctions
between economic and security issues. Simultaneously engines of economic
growth and channels of security risks, they link and incentivize the use of
economic policy tools, such as trade and industrial policies, for broader
security or geopolitical gains.


Thus, we are confronted with a new set of questions. When, if ever, does
restricting digital trade make sense for an individual country? How does
this affect other countries, and how should they respond? What policies and
institutions can deter conflict?


In a recent IMF staff working paper, we show that some of the standard
answers no longer apply in the digital era (Garcia-Macia and Goyal 2020).
Once the key features of digital sectors are considered—large market power
driven by scale economies, technology flows, and security risks—import and
export bans can be rationalized from the point of view of an individual
country. However, these bans come at a deleterious cost for the rest of the
world.


In our analysis, the key motivation for banning technology imports—if a
country hosts a potentially viable supplier—is to repatriate monopoly
profits that would otherwise accrue to foreign firms. The presence of
cybersecurity vulnerabilities only increases the attraction of banning
imports of foreign technology. However, banning imports could halt inflows
of technological knowledge and may be desirable only for a country with
sufficiently advanced technological capacity and know-how. This is not an
entirely new result. Trade economists have long pointed out that banning
imports may be beneficial in monopolistic sectors.


More striking and novel is the finding that banning exports can
also be beneficial for an individual country in the digital economy. The
explanation lies in the dynamics of technological competition between
countries. A challenger country can successfully displace a leader as the
global producer and capture monopoly rents, as a result of international
technology diffusion and domestic scale economies. To forestall such an
outcome and reduce the associated cybersecurity vulnerabilities, the leader
in a certain technology may seek to ban its exports.


Imposing trade bans could lead to retaliation. An import ban might help a
technological power gain an advantage in global markets, although a
competitor might also reciprocate the ban, leading to a worse outcome for
both countries. In many cases, the anticipation of such reciprocity can act
as a powerful deterrent.


Unlike import bans, export bans cannot be deterred with retaliation via
trade policies. A technology leader would impose them irrespective of the
challenger’s response. Hence, they could be harder to defuse in a world of
decentralized international competition.

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Cooperation as a cure


These findings are sobering. Trade bans may benefit an individual country
relative to the free trade outcome. But they cut off other countries from
access to digital technologies or lead to inefficient decoupling into
separate economic spheres. Costs are amplified when allies follow suit.
Leading countries should be urged to set up cooperative frameworks in
several areas.


Securing intellectual property rights across borders should be a priority.
Minimum enforced standards would be in everyone’s interest. They would
reduce concerns about misuse, forced transfers, or theft and thus diminish
the incentives for a technological leader to impose export bans, allowing
for longer periods of diffusion and higher global welfare. Steps toward
defining global standards should start with fostering cooperation in
specific areas. An example is the international standard for electronic
data interchange among financial institutions that facilitates payments.


Clear, transparent, and uniform rules may also be needed on the interaction
between the public and the private sectors. Governments’ partnerships with
domestic cyber technology firms for purportedly national security purposes,
including surveillance, should be clearly ring-fenced.


A related area is cybersecurity. The advent of the internet has facilitated
an explosion in cross-border online crime, for which the national and
international tools, norms, and organizations have yet to be firmly
established. Efforts to cooperate on cybersecurity have been stymied by
competing interests among participants, national security considerations,
differences in judicial and criminal systems, and concerns over misuse by
governments.


Technology wars are becoming the new trade wars.


Facilitating foreign ownership and control of monopolistic digital goods
firms would also broaden the sharing of rents, align incentives for better
global outcomes, and discourage trade conflict. Open financial or capital
accounts to permit such ownership, governance arrangements to facilitate
control, upholding foreign property rights, and narrowly circumscribing
areas subject to national security arguments would be prerequisites.


Regarding regulatory policy, if consideration is given to breaking up large
domestic technology firms to reduce their monopoly profits or otherwise
regulating prices, this ideally should be done in concert across nations.
The absence of a concerted effort could reduce the incentives for any
country to pursue action in this area. If only one country or region moves
toward strong regulation while foreign monopolists are free to compete,
that area could risk falling behind in the race for technology and markets.


Coordinated initiatives to introduce digital taxation would similarly be
much more effective and perceived to be fairer. Tech giants benefit from
selling goods and services online across borders with limited physical
presence and facing little income tax liability in the buyer’s jurisdiction
under existing international tax arrangements. This favors tax arbitrage
and creates an uneven playing field.

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A new Bretton Woods moment


The challenge of international cooperation against a backdrop of mistrust
and competition has led to calls for a new Bretton Woods moment for the
digital age. Just as Bretton Woods brought nations toward a new monetary
order in the wake of two world wars, rampant protectionism, and the Great
Depression, international cooperation on digital matters could similarly
seek consensus on broad principles and common institutions to resolve
problems, such as in the areas outlined above, and help create a
predictable and open framework for international trade.


Another concrete proposal would be to establish a digital stability
board—in the image of the Financial Stability Board—to develop common
standards, regulations, and policies; share best practices; and monitor
risks (Medhora 2021). This could help protect financial stability from
cyberattacks and bring about progress in areas such as a charter of
technological rights, uniform statistics for the digital economy, and
international data trusts to collect and guard individuals’ data for
designated purposes, such as health research.


If, as is expected, the monopoly rents on offer remain large and cyber
warfare is seen as the key arena for security conflicts in the future,
there will be strong domestic resistance to collaboration. In this case,
continued tech conflict, with the risk of a global rupture and its
associated adverse spillovers, looms large. Collaboration would weaken the
incentives for conflict and lead to potentially better outcomes. But it
will require sustained effort and rebuilding trust.


author


DANIEL GARCIA-MACIA
is an economist in the IMF’s European Department.

author

RISHI GOYAL is assistant director of the IMF’s Western
Hemisphere Department.




Opinions expressed in articles and other materials are those of the authors; they do not necessarily represent the views of the IMF and its Executive Board, or IMF policy.



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