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PC News - November 2016

Digital disruption – how should governments respond?

Digital technologies can have significant impacts on markets and competition, workers, households, and society. Many of these effects should be productivity enhancing; but some may result in economic dislocation. A Commission Research Paper examines how governments should respond.

With rapid advances in computing power, connectivity, mobility, and data storage capacity over the last few decades, digital technologies offer opportunities for higher productivity and improvements in living standards. But they may also result in dislocation of labour and capital, and contribute to higher inequality.

Government can influence the adoption of new technologies and how these technologies affect workers, firms, society and the way governments themselves operate. A Productivity Commission Research Paper, ‘Digital Disruption: What Do Governments Need To Do?’, examines the role governments can play in enabling, regulating, and addressing risks posed by the new digital technologies.

What is digital disruption?

The Commission defines disruptive technologies as those technologies that drive substantial change across the economy for many firms, households or workers, with impacts that impose significant costs of adjustment as they make capital obsolete and leave some workers significantly underutilized for some time.

New technologies offer opportunities for the creation of innovative businesses, a greater range or improved quality of products, and new ways for governments to address policy problems. But sometimes firms do not or cannot adapt because of short-sightedness, economic considerations (such as locked-in production methods) or unduly burdensome regulation.

This means existing markets get disrupted. Consumers win, while existing firms have to adjust their business models, or change business, to survive. For example:

  • Netflix and other digital streaming services have rendered the video store obsolete by offering in-home entertainment delivery, along with better selections and guides on what consumers might like.
  • Uber competes with taxi services, through lower prices, ease of booking and payment, and the ability to track arrival times.
New technologies have altered existing modes of production and consumption throughout history, bringing improvements in productivity, better living standards, and higher wages for workers as they share in the productivity gains. Although ICT improvements boosted productivity growth in Australia in the 1990s, further advances in digital technologies have yet to yield measureable productivity gains.

A range of digital and technological developments are likely to be ‘disruptive’

  • Digital intermediaries: platforms, such as Uber, Airbnb, Freelancer, Airtasker, eBay and Seek offer functionalities with low transaction costs and reduced information asymmetries. Some platforms (for example, Airbnb) facilitate greater utilisation of household and other assets.

    Advanced manufacturing: the combination of new materials and digitally advanced design and production methods – including computer-aided design, 3D printing, advanced robotics and the application of the ‘internet of things’. This has blurred the traditional distinction between the manufacturing and services sectors, increasing the demand for workers with relevant STEM skills, and reducing the demand for unskilled labour.

    Transport technologies: sensor technologies that allow for autonomous, semi-autonomous and remotely operated vehicles and aircraft have the potential to change the delivery of transport services and the use of transport infrastructure.

    Energy technologies: advances in information and communication technology combined with distributed energy generation (notably solar and wind) and improved storage technologies have implications for centralised energy transmission and distribution networks, and associated regulatory frameworks.

Digitally-enabled business models

Digital platforms support leaner business models by reducing the transactions costs of outsourcing parts of the production chain. For example, a firm can outsource market research, design, or component manufacturing, assembly, distribution, and marketing. This has always been the case, but digital platforms reduce the transaction costs of finding reliable suppliers of these services. This trend may see a lower share of economy-wide physical capital and employment in very large firms.

Digital technologies create new sources of market power

Digital technologies display characteristics that have been described as ‘weird and wonderful economics’. In contrast to previous waves of technological innovation:

  • Digital products can be replicated at little, if any, cost, offering huge economies of scale.
  • Digital platforms, such as Google, have network features in that they become more valuable to users (searchers, in the case of Google) as the platform becomes more widely used. This is because the information provided by users feeds back into the platform, providing a better product.
  • The data generated by digital transactions and by sensor technologies can become a major resource. For example, Facebook use their data to target advertising to users more likely to purchase the advertised product.

While these characteristics should boost productivity growth, they can also create new sources of market power. Control over networks and data can reduce competition by providing new ways for firms to restrict market entry and extract rent from customers.

Government should monitor the use of this market power to ensure that it does not become entrenched. New regulatory tools may be needed – for example, aspects of third party access regimes may be a relevant approach.

Setting standards to ensure technologies are interoperable would enhance opportunities for new firms and reduce the market power that comes with proprietary standards (that is, specifications for hardware or software controlled by one company, that can only be used under licence).

Regulation should facilitate innovation

The Commission paper argues that regulators should opt to allow new products and business models unless the risks posed are apparent and cannot be managed by current regulation. Outcomes should be regulated, rather than inputs or technologies, as this provides greater scope for firms to innovate.

For example, regulations governing short-term rental platforms, such as Airbnb, should focus on managing any impacts on neighbours, rather than prescribing where such a service can and cannot be provided.

Governments need to ensure that redress is available as an effective deterrent to poor behavior by market participants. Generic regulation, such as consumer protection, may offer better protection from defective products than mandating detailed technical specifications.

The two-way flow of information in the digital market place, as well as the speed of feedback, imposes discipline on both sellers and buyers to behave honestly. More information for consumers is particularly important in markets where purchases are less frequent, such as consumer durables or product repair services.

In some product and service markets, government should shift the regulatory focus from product compliance to ensuring that the product information on comparison platforms is reliable.

Assisting labour force adjustment

Digital technologies such as robotics, automation, and machine learning, will replace a number of functions currently undertaken by workers. There are some alarming estimates that 9 to 40 per cent of existing jobs may become obsolete. However, there remains considerable uncertainty about the impact of automation on employment.

Improving government service delivery

  • Governments have been relatively slow to adopt digital technologies. There is considerable scope for governments to use the new technologies to improve processes:

    • digital technologies can make regulation less burdensome and more efficient, and improve compliance monitoring
    • automation and integration of human service delivery could reduce costs, allow better targeting of services, and facilitate greater consumer choice
    • use of remote monitoring, such as through embedded sensors, could improve provision of government services, including better planning, management and funding of public infrastructure.

    The fall in the cost of sharing data and communications reduces the justifications for agency silos. More cooperative approaches to service delivery and more efficient contract management are potential sources of productivity improvement.

    The opportunities for government to make a difference from many small changes in response to digital technologies are large. Some changes are being embraced, such as the NSW and ACT governments’ supportive response to regulating Uber. Others have yet to be pursued. The opportunities provided by a digital world are considerable – there is much governments can do to realise them.

Disruptive technologies may increase wage inequality, arising from a widening gap in the productivity performance of firms (and the corresponding returns to labour) and from higher wages for those with talents and skills in short supply.

Trends towards a concentration of income growth at the top end of the labour market pose some risk to growth in demand, which is needed to drive investment and employment. Government needs to consider how to maintain demand growth where markets deliver growing income inequality.

While government investment in education and training can assist workers to acquire new skills required for the digital economy, simply increasing the share of STEM (science, technology, engineering and mathematics) graduates is unlikely to resolve the low rates of adoption of digital technologies by firms.

Communication and problem-solving skills are also needed, and a focus on life-long learning as the pace of change means skills are likely to become redundant more quickly.

The social safety net may also need fine tuning to support labour force adjustment. To the extent that firms move to very lean production models they will hire workers only as needed.

Platforms – such as Freelancer, Airtasker and 99designs – will facilitate on-demand or ‘gig’ employment. While some people will use these employment platforms to earn extra income, the platforms also offer a new business model for contractors and the self-employed.

This model provides considerable flexibility in work hours, but comes at some risk to income security. This may not suit all workers, and some may struggle to attain a full-time employment-equivalent income. Governments will need to pay attention to social safety nets and workplace relations law, should ‘gig’ work become widespread.

Protecting privacy and enhancing security

The pervasive nature of sensors, internet-linked products and online transactions, and the capacity of firms to collect and analyse data, and of data brokers to combine data for on-selling, raise many questions about the protection of privacy.

They also raise questions about what control individuals have over the data collected about them. These, and related issues, are examined in the Commission’s current inquiry into Data Availability and Use.

The networked nature of infrastructure, and the growing value of data assets also make cybersecurity an ever more important concern for government as well as firms.

Digital Disruption: What Do Governments Need to Do?

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