The challenges facing the State in the new digital economy

The adoption of new digital technologies has represented a revolution for both firms and individuals, changing the way in which they are organised, how they relate to each other and also how they shop. Nevertheless such changes also entail significant challenges for the State as it has to regulate activities that previously did not exist or for which the current legislation is not appropriate. In this article we will analyse the role played by the State in terms of competition, tax revenue and global governance in a digitalised world.

Starting with competition, it is important to note that new digital technologies can reduce competition or even encourage monopolies. Traditionally, when a firm (technological or otherwise) achieves considerable market share and has a leading standard platform it may be tempted to abuse its dominant position by restricting competition. Technological advances in the digital era have helped several technology giants (Microsoft, Google, Apple, etc.) to take up such an advantageous situation. However, new digital technologies also open the door to competition as they allow new rivals to appear on the scene by simplifying the process required to become a provider of goods and services. For example, new apps for mobiles have made peer-to-peer or P2P transactions easier in regulated sectors such as rented accommodation and passenger transport, which have experienced a boom in the last few years.

This increased supply as a consequence of better technology has a positive side for consumers as it increases existing competition thanks to the greater number and variety of goods and services offered and can also reduce the price. However, the disruptive appearance of new agents can also lead to unfair competition regarding existing service providers which, unlike the new kids on the block, have had to respect the rules regarding security, safety and quality standards or obtain licences to operate, among other issues. Technological innovation makes it possible for new agents to do business and it is impossible (and surely not at all desirable) to restrict this completely. But they should have to comply with some basic requirements, both at the start of the business (for example, following consumer protection requirements) and while carrying out the activity (for example, paying tax), and they should also operate legally. Legislation also needs to adapt to the new business model and technological improvements. For example, the need to pass a test proving a thorough knowledge of the streets in a city to obtain a passenger transport licence may no longer be appropriate, now that there are mobile phones with GPS and anyone can take people to a precise address without having to memorise all the different routes (as well as facilitating contact with clients via a P2P app). In short, the State needs to develop a more flexible, broader regulatory framework that responds to this new situation but does not make it unnecessarily difficult for new agents to enter the market.

Another important issue is consumer protection legislation and quality and safety standards, whose compliance must be guaranteed by the State, a complicated task in a digital economy which, by its very nature, has no borders. Legislative harmonisation between the different countries in the European Union (EU) and also within them would be an improvement in this respect as it would increase consumer protection at the same time as boosting the digital economy. In Spain, for example, there are different regulations related to tourist apartments depending on the autonomous community and even the municipality, making it difficult to control this activity and also to develop it.

In the fiscal area, the challenge facing the State is how to tax online business. Some large technological firms have managed to reduce their tax bill by placing their sales in countries with lower taxes instead of the country where the buyer is actually making the transaction. Similarly, in order to avoid paying tax in countries with higher rates, they transfer part of their profits to subsidiaries in countries with lower rates. To do so they use transfer pricing arrangements that shift most of the profits to another domicile. The European Commission is analysing the possible distortion of competition of various tax breaks granted by, among others, Ireland (in the case of Apple) and Luxembourg (in the case of Amazon). Harmonised legislation, at least between EU countries, would reduce this problem, as well as the effective supervision of transfers between subsidiaries to ensure they comply with the law. On the other hand, at present tax cannot be levied on part of the income obtained for providing goods and services via digital media as actual legislation is not adapted. For example, drivers using passenger transport apps, which have yet to be legalised, do not pay VAT on their transactions. However, P2P apps could help to improve tax payment since they increase the traceability of transactions, making it difficult for commercial exchanges to remain off the record.

Lastly, the third area of utmost importance for the State is the global governance of digital flows. We shall use the internet as a case in point as this helps to make a debate that is sometimes too generic a little more concrete, as well as the fact that it is the medium through which a large part of digitalised globalisation is occurring. The internet owes its success to being a single, global system, in particular its main protocols and infrastructures. But today there are two points of friction that could erode these principles: net neutrality and cybersecurity.

Net neutrality means that all data must be treated equally, without discrimination due to origin or content; consequently the internet is sometimes seen as a single service instead of a network with different categories. In practice this means, for instance, prohibiting the firm that owns the infrastructure to charge for some data to be transmitted more quickly. However, it also reduces companies' incentives to innovate and invest as they lose a way of getting a return on their investment. Individual users want to access all information without filters but they also want improvements and innovation in the infrastructures they use, at the lowest cost possible.

Lastly, cybersecurity is a critical issue for governments: the size of cybercrime is now comparable in volume with drug trafficking.1 It is not easy to balance internet security (which should be desirable for all parties) with internet control to ensure national and international security. For some governments the internet might represent a political risk or they may want to use it as a means of controlling their citizens. In any case using the internet to achieve national political goals damages its integrity and functionality. One relatively optimal solution from a theoretical point of view would be to create a neutral zone where the internet backbone were «governed» by a multilateral body incorporating all parties (governments, companies, consumers, etc.). However, it seems difficult to put this idea into practice due to the differing economic interests and the political disparity of the agents involved.

In conclusion, although technological innovations represent an important step forward for society they are also a source of crucial challenges for States. It is important for them to be regulated appropriately to increase the well-being ot the population by taking their preferences into account. But it would be a mistake if excessive or obsolete regulation restricted the resulting possibilities for growth.

Josep Mestres Domènech

Macroeconomics Unit, Strategic Planning and Research Department, CaixaBank

1. Javier Solana, «Cyber War and Peace», Project Syndicate, 30 April 2015.