The market failures of Big Tech

One of the great economic policy questions of today is how — and for some, even whether — we should regulate digital technology companies. The answer we adopt has implications far beyond economics: it is now abundantly clear that internet businesses have pervasive effects on our social and political lives. But there are also straightforward economic aspects to address about the dominance of internet companies in many sectors. That is why we devote Free Lunch this week to a series of posts about how to deal with Big Tech.

Big Tech professes to love competition; everyone who has crushed their competitors once does. But let us be clear from the outset that this is not disinterested love. Any company that can claim to be thriving in a highly competitive environment is also aiming to short-circuit economic arguments for regulating it for the greater good. Economic arguments for interfering with market dominance should establish the presence of “market failure” — that is, some feature of the market that means it does not in practice produce the good results of idealised perfect competition. To claim that competition is strong is to deny the existence of market failures.

That is a denial we should not accept in most cases of Big Tech dominance. Here are four obstacles to competition inherent in internet-based businesses, some of which apply to almost any famous online giant you may care to name.

First, “network externalities” create economies of scale. Search engines, social media and shopping, matching or selection platforms all can perform their functions better the more people use the service. That makes it hard for new challengers to compete.

Second, many internet companies enjoy economies of scale in the operation itself quite apart from network effects. Amazon’s sheer scale and geographic reach must reduce its unit costs considerably, regardless of its number of customers. And purely internet-based activity, such as that of companies that match buyers and sellers rather than selling their own stock, is inordinately cheap to scale up.

Third, the fact that internet companies collect huge amounts of data on their customers creates economies of scope as well as economics of scale. That means that scale in one type of activity creates advantages in another. A prime example is the European Commission’s fully justified finding that Google abused its dominance in search to create advantages in comparison shopping. Another, of course, is how media companies benefit from user activity patterns to offer better targeted ad placements to advertisers. This in effect subsidises the colonisation of new tracts of the internet economy by those already dominant in one field. 

Fourth, some internet business activities — social media are the obvious case — are designed to be addictive. Don’t take my word for it: the software engineer who invented Facebook’s “like” button confirms it. He and a number of other pioneers of the internet economy as we know it are having a Dr Frankenstein moment, organising to undo the monster they have brought into the world.

It is a psychological and social challenge that some internet services create real and sometimes serious addictions. But here we are interested in the economic challenge this poses. There is venerable literature on the economics of addiction and “bounded rationality” more generally. But the general point is that in the presence of consumers suffering from weakness of will — a fortiori when businesses have designed their product to weaken their will and exploit that weakness — that too amounts to a market failure. It means we cannot take the claim (even if it were true) that the pedlars of addictive internet products are exposed to competition to indicate that this competition, such as it is, produces the good outcomes competition is normally expected to do.

Network externalities, economies of scale, economics of scope (because of data) and addictiveness all make Big Tech a huge economic problem. They are independent, and serious, reasons why the dominance of a few companies in a range of internet-based services should be seen as economically dysfunctional — against the frequent claim that the availabilitygood products at low or zero prices means there is no problem.

On Tuesday we will examine the kind of economic damage wrought by what are in effect failures of competition. The rest of the week we will examine proposals for policies to deal with these failures.

Other readables

  • How will the US fiscal stimulus affect the country’s external deficit? Gavyn Davies harks back to past “twin deficit” episodes, and concludes: “It is not the twin deficits per se, but the Fed’s reaction to them, that is the real threat to the markets.” 
  • Labour migration is difficult to manage in Asia, too. Nikkei Asian Review examines crackdowns on migrant workers in Malaysia and Thailand.

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The market failures of Big Tech

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