The concentration of economic power in digital giants is occurring at a time when globalisation is fracturing due to competing industrial policies and protectionism. This seemingly paradoxical development is caused by two transformative events in the global economy – the world is entering the fourth industrial revolution at a time when economic hegemony has come to an end, writes Valdai Club expert Glenn Diesen.
The fourth industrial revolution
The fourth industrial revolution entails digital technologies merging with the real world. Through artificial intelligence, robotics, automation and other innovations, digital giants are revolutionising and conquering industries that previously belonged to the physical world. Digital giants initially changed communication, but are now transforming production, transportation, banking, cities, armies, the medical industry and every other area of the economy.
The most important competitive advantage in the fourth industrial revolution is to have independent digital ecosystems such as Yandex or Sber. Digital technologies enjoy the “economies of scope”, in which it is less costly to combine two or more product lines or industries rather than produce them separately. High fixed costs and low variable costs of digital technologies with cross-industry synergy effects create an opportune situation for monopolies to emerge. In the fourth industrial revolution, companies operating search engines or e-commerce sites have a competitive advantage in creating automated vehicles, absorbing the taxi industry, developing automated weapon systems, creating digital currencies, and sending people to space. Computing power, data acquisition and synergy effects enable a few digital giants to dominate seemingly unrelated industries.
The concentration of power has immense consequences on the international economic system. Governments support large national champions that are competitive in international markets, yet are apprehensive about their unwarranted domestic political influence.
Asymmetrical economic interdependence between states is a source of political power as states can maximise both autonomy and influence. High-tech industries are defined as strategic industries due to the limited ability to diversify suppliers, which creates a dilemma for weaker states to choose between economic efficiency or autonomy.
All major states subsequently desire technological sovereignty – their own digital ecosystem to avoid excessive reliance and even technological colonialism. Centralised economic tools such as the US dollar and SWIFT enable the US to wield immense political power, which should be a cautionary tale for other states as all industries are reorganised around digital giants.
The end of economic hegemony
Globalisation has been tantamount to Americanisation over the past decades as the world followed a liberal economic format under US economic hegemony. This format for globalisation is disrupted due to the relative decline of the US as the economic hegemon, which also ends the international liberal economic system. Economic liberalism is commonly misunderstood as an independent variable, a value that shapes the international system. In reality, liberal international economic systems emerge when there is a concentration of economic power under a hegemon such as under Britain in the 19th century and the US in the 20th century.
Both Britain and the US grew into a dominant position in international markets with forceful industrial policies and protectionism through the use of subsidies and tariffs. However, once in a dominant position, both Britain and the US embraced the virtue of economic liberalism to cement their economic hegemony. Technological leadership is cemented when the mature industries (high quality, low cost) of the technological leader is in open and direct competition with the infant industries (low quality, high costs) of the developing states. David Ricardo developed the liberal economic theory of comparative advantage as an instrument of cementing British technological leadership: “It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England”.
Friedrich List famously criticised British advocacy of free trade as an hegemonic norm to “kick away the ladder”:
It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him. In this lies the secret of the cosmopolitical doctrine of Adam Smith, and of the cosmopolitical tendencies of his great contemporary William Pitt, and of all his successors in the British Government administrations.
In the 19th century, rising powers such as the US, Germany, France and Russia embraced economic nationalist policies to various degrees in which they used temporary tariffs and subsidies for their infant industries until they had matured and thus become competitive in international markets. The policy recommendations of Alexander Hamilton that laid the foundations of the American system were mirrored in the ideas of Friedrich List and Sergey Witte. List acknowledged that states had to recognise that economic power is a significant instrument of power and that excessive unfavourable asymmetrical interdependence would create core-periphery relations:
As long as the division of the human race into independent nations exists, political economy will as often be at variance with cosmopolitan principles… a nation would act unwisely to endeavour to promote the welfare of the whole human race at the expense of its particular strength, welfare and independence.
In the mid-20th century, the US similarly cemented its technological leadership. US technological leadership continued during the development of digital technologies as the US government-funded innovation in Silicon Valley with large military contracts and funding universities to develop patents. Once in a dominant position, technological leadership was cemented with liberal economics and trade agreements that extended end enforced patent laws and intellectual property to slow down the diffusion of technologies.
In the 21st century, China has spearheaded the same economic nationalist policies as the US pursued in the 19th century, by using direct and indirect subsidies and tariffs to climb up global value chains. China has caught up and is currently establishing leadership in strategic industries. With the forceful industrial policy China 2025, Beijing aims to establish technological leadership in artificial intelligence, robotics, and the other leading technologies associated with the fourth industrial revolution.
Subsequently, when the concentration of economic power under a hegemon diminishes, “the liberal order is expected to unravel and its regimes to become weaker, ultimately being replaced by mercantilist arrangements” and national authority is prioritised above market forces. The economic war between the US and China is the predictable result of a declining and insecure hegemon. The US increasingly uses its administrative role in the international economy to weaken adversaries such as China and Russia with economic coercion, thereby contributing to unravelling the liberal economic system and creating further incentives for these states to reduce reliance on the US.
China and the US will cooperate for mutual gain in areas where it does not result in excessive reliance on the counterpart. China and the US will both ensure that their own digital platforms are dominant on the domestic market, which the US is also advancing under the logic of what is good for Silicon Valley should be good for the US. Meanwhile illiberal practises define the international economy as the US and China compete for relative gain in markets of third countries, as evident by the fierce 5G rivalry.
A Russian strategy of technological preparedness
The rise of digital giants in a less liberal international economic system affects how Russian companies should cooperate and compete with foreign counterparts. The Russian state should intervene in the market to ensure that the dominant digital giants in the domestic market are Russian. However, full autonomy is a fool’s errand, as it will create weak and inefficient Russian companies. A balance must be struck between technological sovereignty and market efficiency.
Russia does not have the capabilities to outcompete the US and China, however, it does not need to be the technological leader. Russia’s ideal strategy is that of “technological preparedness” in which Russia has the technological know-how and infrastructure/digital ecosystem to launch domestic spin-offs to enhance strategic autonomy. The strategies of technological followers entail reducing the first-mover advantage of the technological leader by encouraging faster diffusion of technologies. Technological partnerships with foreign companies should thus be aimed towards joint ventures with the majority share and transfer of technology and know-how. There is a faster diffusion of technology in the absence of an economic hegemon, which provides opportunities for rising powers such as Russia that strives for technological sovereignty. Diversifying technological partnership is imperative to shift the advantage in favour of the technological follower. Furthermore, revenue from sales of energy resources should fund direct and indirect subsidies to develop mature digital industries, while the necessity of national security and the sanctions war with the West should be used for indirect tariffs and import substitution for sensitive industries.
The trend towards the fragmentation of the internet and nationalisation of the digital space should be welcomed by Russia. Over the past years, Russia has inoculated itself against sanctions on its financial markets to reduce vulnerability to Western economic coercion, this is also extended to the technology sector. These policies should not be confused with isolationism or autarchy, rather it demands that cooperation and competition finds a balance between economic liberalism and technological sovereignty.