How internet giants damage the economy and society

In the first part of our Free Lunch series on the economic challenges of Big Tech on Monday, we listed a number of “market failures” — reasons why many online services are protected from competitive pressure, or why competition in these sectors will not produce the good social outcomes predicted in the simplest economic models. We mentioned network externalities, economies of scale, economies of scope (how the data gathered through one product create commercial advantages against competitors in another market) and the addictiveness of some products.

What sort of economic harm do these market failures cause?

Above all, the classic consequence of insufficient competition: the extraction of “economic rent” — profits over and above what is necessary to encourage the product or service to be provided in the first place. Economic rent is the main reason why the internet giants are so wildly valuable — because they either enjoy profits beyond any proportion to their cost or are expected by investors to do so in the foreseeable future.

The flip side of economic rent is almost always an inefficiency. It is as sure a sign of monopoly power and lack of competition as high prices and poor quality would be. Some claim that when consumers get their products for free, there cannot be a problem of anti-competitive behaviour. Some internet companies such as matching platforms, however, do not offer their products for free at all — consider the commissions charged by Uber or Airbnb. In any case, it’s not just prices we should look at, but profits. Put differently, look not at free Google searches or Facebook profiles, but at the prices determining how much money the Googles and Facebooks of this world actually make: what they charge for their advertising and what they pay for their raw material, ie behavioural data. Such companies do well because their market dominance allows them to charge more for the former and pay nothing for the latter. Real competition would change this.

The industry’s apologists like to argue that because a new product can come around at any moment, today’s giants live under constant competitive threat even if it may not seem so. But as I have explained before, this is a weak claim: they have many defences against potential rivals, and even if they are eventually toppled, dominance causes economic harm as long as it is enjoyed (and may continue if the new rival just usurps the dominant position).

The extraction of economic rent, and the inefficiency that accompanies it, is a problem as old as markets themselves. But there are particular features of the digital economy that exacerbate its noxious effects.

First, the intangible nature of internet services makes it particularly easy for them to avoid taxation through jurisdiction-hopping — the first policy priority in the presence of economic rent, which we will address in more detail on Wednesday.

Second, the unprecedented data-gathering that goes hand in hand with the provision of online services has a number of remarkable consequences that combine to aggravate the economic problem of rent extraction. It facilitates price discrimination at a fine-grained individual level: the more you know about your customers, the better you can set a price that captures almost their entire benefit from the service. Addictiveness, when present, only makes this worse. Further, the fact that such information is useful for distribution and marketing in general allows internet companies to ensconce themselves in a broad range of traditional industries, and thus extract economic surplus from them. (We in the media are just one of many sectors feeling this pinch!) And finally, the flip side of internet companies’ vanishingly small need for human employees relative to the value they capture means that very little of the returns to investmentneed to be dissipated to pay for labour.

Put all these phenomena together, and you get a tendency towards exacerbating a shift in incomes from labour to capital, and a more intense inequality of labour incomes. Both are at the heart of the economic changes that have produced populist insurgencies in many rich countries since the 1980s.

In this brief survey of economic harms due to market power in the digital economy, we have not even touched on the most talked-about worries: the use of the internet for manipulation, or digital companies’ systemic effect on how our societies function. My point here is simply that even looking only at fairly traditional economic harms, there are deep problems in need of fixing. The rest of this week we will examine possible ways to do so.

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How internet giants damage the economy and society

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