The Economic Benefits of a Free And Open Internet

Rodney D. Ludema
Chief Economist, Office of the Chief Economist
Remarks before the Seoul Financial Forum
Seoul, South Korea
October 20, 2014

As Prepared for Delivery

I would like to extend my gratitude to Seoul Financial Forum and Chairman Kim for your generosity in hosting me today. I appreciate the opportunity to address an esteemed audience in South Korea, one of the most Internet-connected countries in the world.

I want to begin this morning with a question: What kind of economy will the next generation inherit? There are two long-term global trends that can help us to answer this question.

First, we are getting older. The median age in developed countries is now over 40. This is because we are living longer and birth rates are lower, resulting in slower labor force growth and a rising ratio of retirees to workers. Without growth in the labor force, where will the growth come from that we need to support these retirees?

The second trend is the rise of the service sector. One hundred years ago, most of the world worked in agriculture. Over the ensuing decades, agriculture was displaced my manufacturing. Today, manufacturing is on the decline and services are ascendant. In 1980, less than half of world output was in the form of services. Today it is over 70 percent. Meanwhile, manufacturing has fallen to less than 30 percent of world GDP, with the share of employment in manufacturing even lower. This is not a story of manufacturing moving from advanced to emerging economies. We see the service sector growing in developed countries and developing countries alike. Even in China, the world’s manufacturing juggernaut, the share of services in GDP has risen to over 50 percent. What is driving this tectonic shift in the world economy, and how can countries best position themselves to take advantage of it?

It turns out that all of these questions have the same answer: the Internet. The Internet is driving large changes in the global economy and, I believe, will continue to drive productivity growth well into the future, provided we foster an open, interoperable, and free Internet.

Writing in the early 19th century, the British economist David Ricardo predicted that the industrial revolution would drive down the price of manufactured goods thus making agricultural goods relatively more expensive, to the benefit of agricultural producers. A century later, the economists Raúl Prebisch and Hans Singer reviewed the historical data and discovered that Ricardo had been wrong: the relative price of agriculture had actually declined steadily since the industrial revolution. They concluded that something was wrong with the world economy, that agricultural production was for losers, and that countries needed to industrialize at all costs. This led to decades of disastrous import substitution policies. It turns out they were all wrong, because manufacturing grew through quality and variety improvements – not price declines – and agriculture grew and got cheaper, thanks to capital-intensive farming with economies of scale.

This is what is happening today with manufacturing. It is not declining in absolute terms, rather, manufacturing is becoming more efficient, thanks to an array of Internet-enabled advances in, for example, communications, inventory management, global value chains, and e-commerce. All this drives down prices.

At the same time, an increasing share of the value added in manufacturing is coming from services. Who makes money on manufacturing today? It is the designers, engineers, marketers, financial services companies, logistics companies, and IT companies. All of these are Internet-enabled services. Further, you can see that there is a high correlation between Internet usage and services across countries. While correlation is not causation, the case is strong that it is Internet-enabled services in particular that is driving the overall growth in services. This can be seen, for example, internationally traded services in the U.S. Almost all of the growth in both services imports and exports in the last decade has come from Internet-enabled services.

By now I hope I have convinced you of two things: one, our children will earn their livelihoods working in ICT-enabled services, and; two, that the benefits of the Internet extend well beyond the ICT sector itself and increase productivity in other sectors across the economy. In fact, a recent McKinsey survey found that 75 percent of the benefits go to companies that are not part of the ICT sector. The Internet is what economists call a “general purpose technology.” Other examples include steam power, railroads, electricity, and automobiles. These technologies impact virtually every other sector and change the way we live and do business.

Business models and strategies that before may have elicited more attention from economic theorists than actual businesses are now being implemented thanks to the Internet and related technologies. Auctions, price discrimination, and product bundling are nothing new in the marketplace, but the ease with which they can be employed online has been crucial to the success of companies like eBay, Amazon, and Coupang.

Will the Internet continue to drive productivity growth into the future? Some have argued that since we have reached saturation, the fast growth of the internet economy is over. I think this view is incorrect for two reasons:

First, the rest of the world is not saturated at all. And since the Internet is a global network, its value to all users grows as the number of users grows. There are nearly 3 billion Internet users globally, and that number will likely grow to 5 billion by 2020. The Internet economies of the developed world are projected to grow at 8 percent annually over the next five years, so that by 2016, the digital economy will equate to the fifth largest economy in the world, contributing over $4.2 trillion to the G-20’s collective GDP. The same McKinsey study I mentioned earlier predicted that global flows of goods, services and finance could triple to $85 trillion by 2025, powered by the spread of the Internet and digital technologies.

Second, general purpose technologies also serve as platforms for innovation. Think of all the innovation made possible by electricity long after its saturation point. We are already beginning to see that future of Internet technology will look like. Big data – firms have only begun to make use of the reams of data the Internet provides. The “App” economy – mobile phones have grown faster than Internet use in recent years. Linking these technologies together offers vast opportunities for creative applications. The Internet of things – Internet-linked mobile technology can also be installed in other devises to create smart appliances.

So, yes, the growth in productivity brought about by the Internet could very well continue. Given the importance of the Internet for the future, it is vitally important that we take steps now to keep it vibrant.

Policies that restrict these flows of data, such as data localization requirements, impair this economic growth. Data localization requirements are effectively non-tariff trade barriers that disrupt the foreign provision of a digital service in a country. Such a ban can be introduced economy-wide, as is the case in China and Vietnam, or selectively to a particular sector, such as the restrictions to the financial sector found in Korea.

I hope that the implementation of the financial service data transfer provisions in KORUS (the Korea –U.S. Free Trade Agreement) will become more streamlined and efficient so as to avoid forcing foreign financial institutions to create Korea-unique patches and work-arounds when they upgrade their global systems. If Seoul is to position itself as a global center of finance, it must rethink its restrictions on outsourcing of data processing for financial services industry. The penalty for being left behind is rising.

Recent localization and privacy requirements that have been proposed stem from a fundamental misunderstanding of how the Internet works. Ultimately, these costly data protection measures reduce efficiency, increase costs to local businesses, block access to customers abroad – and they simply do not provide the data security they are intended to. Localization and privacy requirements are not the only policies that serve as barriers to digital trade. Market access limitations, intellectual property rights infringement, unclear legal liabilities, complicated customs measures, and censorship all stifle the flow of data.

It is not just large ICT companies that stand to lose out due to these policies. Restrictive regulation heavily impacts the domestic economy by decreasing productivity, hampering exports and discouraging investment. Many SMEs rely on cloud service providers and other Internet-based platforms to store and process business data and to extend their own international reach into markets overseas. The global free flow of data also goes hand in hand with the global free flow of financial services, including sources of credit and investment that are crucial for entrepreneurs. When large commercial actors are hindered in using or moving data, it affects the smaller actors as well.

President Park Geun-hye announced plans earlier this year to spur innovation and build a creative economy as a means of achieving future economic growth. Free and open data flows are essential for innovative Internet Korean start-ups nurtured under this plan to grow beyond the domestic market and find success on the global stage.

Greater openness encourages greater usage of the Internet, and the real value of the digital economy comes from increased usage of the Internet and related technologies. When people can access the content they want on the Internet, they use it more, and greater use of the Internet is ultimately a more important driver of growth than domestic ICT development. Policies impacting Internet use in one country have “spillover” effects on users in other countries. This interconnectedness provides a reason to cooperate with like-minded countries in promoting Internet openness and freedom, and to advocate for free and open Internet policies when engaging with countries that unwisely choose to limit access.

The Internet is a network of networks which like a road network or telephone network, increases in value to every user as it gets larger. Each new user is both a source and a destination for information, goods, services, etc. If the Internet becomes walled-off, however, then the marginal benefits of continued growth will be diminished for everyone. The open Internet is a shared interest and maintaining it is a shared responsibility.

I should note that in Busan today, the International Telecommunications Union convenes its quadrennial Plenipotentiary Conference. This conference will discuss the important issue of developing international telecommunications, and we believe these issues are vitally important to the global economy. A part of that discussion will likely focus on the Internet. As business leaders in an industry which stands to gain – or lose – so much depending on how we collectively move forward on Internet policy and data restriction, it is critical that you engage in this conversation with policy makers and civil society.

The United States has tremendous appreciation for Korea’s remarkable development, supported by effective use of technology, over the last few decades and welcomes President Park’s emphasis on fostering creative and innovative economic growth. Sustaining the current inclusive, multi-stakeholder model of Internet governance is essential to preserving the free and open Internet that helps promote creativity and ingenuity in the economy. The Internet is not only a technology, but a socioeconomic space created jointly by individuals, companies and sovereign nations, all of whom have a stake in how it evolves. It is therefore important that participants at the ITU Plenipotentiary Conference confirm the ITU’s critical role in developing international telecommunications, including spectrum management, telecommunications standardization, and development, but do not undermine the role of all stakeholders in developing communications networks, including the Internet, or its governance.

In summary, the Internet is rapidly transforming global trade and driving economic growth. The openness of the Internet – that is, the ability for data to flow unimpeded across its networks and for users to access content – is critical to maintaining this growth. Given the importance of the Internet for the future, it is vitally important that we take steps now to keep this technology vibrant and continue to foster innovation. The Internet is the shared interest of businesses, governments, and billions of individuals around the globe; as such, it is also the shared responsibility of all stakeholders to preserve the free and open Internet.

Thank you for giving the opportunity to talk to you to today about an issue that which impacts all of us. My only regret is that my stay in Seoul is so short. I hope in the future to more opportunities to enjoy your city especially when it is cloaked in the beautiful colors of autumn. I’d be happy to entertain your questions.