Better regulation of digital platform markets in Germany and the EU

_ Yuri Kofner, junior economist, MIWI – Institute for Market Integration and Economic Policy. Munich, 25 March 2021.

Digitization (Industry 4.0) is a dynamic, disruptive structural change that is increasingly having an impact on the German and European economies – mainly through the monopoly of American Internet companies’ market power, accompanied by inadequate regulation of digital platform markets.

Digital platforms are typically online matchmakers or technology frameworks. By far the most common type is “transaction platforms”, also known as “digital matchmakers”. Examples of transaction platforms include Amazon, Airbnb, Uber, and Baidu.

A second type is the “innovation platform”, which provides a common technology framework, upon which others can build (by using APIs), such as the many independent developers who work on Microsoft’s platform.

Corona accelerated the rise of digital platforms in Germany and the EU

According to the findings of the Munich-based ifo Institute, the sales growth in digital platform markets in Germany in recent years has been well above the average for stationary retail. Due to the corona restrictions, digital platforms recorded a strong sales growth of almost 10 percent in the first quarter of 2020 (compared with a plus of 3.9 percent on average in retail and almost minus 70 percent in the automotive industry). The major internet corporations, above all Amazon, have benefited significantly from the Corona restrictions. In the first quarter of 2020, Amazon’s global sales increased by more than 25 percent year-on-year. Their growth in sales in Germany is also likely to have been in the double-digit range.

But even though Amazon has increasingly positioned itself as a marketplace, the participating merchants were not able to benefit to the same extent from the rising online demand. In Germany, the Bundeskartellamt is currently investigating if Amazon exploited its market power as a digital platform at the cost of its participating merchants.[1]

In the EU, between 2010 and 2019 the percentage of individuals using internet purchases has increased from 27 to almost 50 percent. [2]

According to a recent survey by UPS, which was conducted when the Corona restrictions took effect, 58 percent of almost 250 European e-commerce companies rated their economic situation as positive or very positive. Around three quarters expect their revenue to increase over the next 5 years. Almost half of these e-commerce companies sell through online marketplaces, such as Amazon and eBay.[3]

Network effects and monopolistic power of digital platforms

The digital platform economy forces national and European anti-trust regulatory bodies to adopt new and more complex approaches to ensure competition as the underlying basis of the social market economy.

This is due to the fact that digital platforms along with their use of big data create a significant market power for themselves, which can potentially compromise the competitive environment and even the national economic security for the following reasons:

First of all, due to so-called network effects, market power is concentrated in some digital platform companies, which makes lively competition difficult. Network effects are present when the value of being with a service or network depends on the number of users of this service. The more users there are, the more useful the network becomes for each user individually and as a whole. Such network effects can be increased by the power of big data.

Secondly, in addition to network effects, high switching costs favor a lack of interoperability, which can also lead to a lock-in situation for users and promote market concentration.

Thirdly, there is another dimension: a rapid increase in the concentration of the market power in so-called “the-winner-takes-it-all” markets leads to large economies of scale and some companies in these markets are able to generate extra profits. For example, Google (with YouTube, image search, and maps) has a market share of 90.8 percent. The remaining 9.2 percent are shared by other platforms, such as Yahoo, Amazon, and Bing.[4]

Fourthly, the digital economy has another special feature. While in regular markets an increased market power tends to lead to a decline in innovation, powerful digital companies tend to be drivers for innovation. In a global comparison, they are among the companies that spend the most on research and development (R&D). The research budget of Amazon and Google in 2017 alone was USD 16.1 bln and USD 13.9 bln respectively, which combined is only slightly lower than Germany’s total R&D expenditure in the same year, equal to appr. USD 19.3 bln (Wambach, 2019).

Furthermore, there is also a general rule that market power per se is not prohibited.  It is only prohibited if market power is exploited for unfair practices. In order to react appropriately to the new effects of the “platformization”, policymakers should apply regulations that do not punish the innovation potential and added value of globalized digitalization. Such regulations could be based on the following principles:

Transparency requirement for the effects of algorithms

First, an important element that is relevant to both competition and data protection is transparency about the use of the data, which would help reduce information asymmetries and enable client users to react better to certain offers on the platforms. In this way, clients can better react to how, by whom, and for which purposes their data is being collected by digital companies.

A transparency requirement for the effects of algorithms would be advisable so that users can reliably assess whether the network is trying to influence them and that they can make their own decisions about which filters and personalizations they want to accept in the digital world – and which they don’t.

If algorithms make decisions automatically, they should in principle be verifiable for compliance with prohibitions on discrimination, data protection law, competition law and other legal requirements. For this reason, a transparency requirement for the effects of algorithms is necessary so that consumers and legislators can reliably assess whether digital platform companies violate prohibitions on discrimination, data protection law, competition law and other legal requirements.

Data portability and ease of switching

Second, another way to increase competition between digital platforms is to reduce switching costs. A switch between platforms may be impaired due to too high price or due to data protection problems. Interoperability should therefore be a requirement of the legislator towards platform companies.

Third, data portability, which treats the client data as a property, is another related measure. The European General Data Protection Regulation (GDPR), which entered into force in May 2018, contains the right to data portability, i.e. users of a platform are entitled to request that their data be made available to them. The expectation is that the possibility to transfer data from one platform to a competing one will also add to the competitive pressure.

Parcelization and de minimis trade

Digital platforms are likely to change the global trade patterns through “parcelization”, more often referred to as “de minimis trade”. The growth of online platforms has led to a rising number of small packages being sold across international borders. In 2015, e-commerce transactions were estimated at USD 260 bln worldwide, which were largely dominated by cross-border orders from domestic households (76 percent). This gives rise to a number of issues for policymakers, ranging from the physical management of the parcel trade to the implications for risk management (such as those related to counterfeit goods or biosecurity standards), and revenue implications related to the collection of taxes and tariffs.[5]

Parcel trade offers an important opportunity for firms, including those who otherwise do not have a sufficient domestic customer base. In the U.S., for instance, 97 percent of small businesses rely on eBay-enabled export, compared to just 4 percent of offline peers.[6] Governments can support these SMEs by removing procedural burdens and by streamlining administrative procedures for handling parcels at the border.

On the other hand, parcelization can lead to the under-recording of trade. Households and firms increasingly use platforms for direct imports, and these may not be picked up in the official statistics, especially if a platform operates a local domain site. The sheer number of traded parcels poses new challenges for the customs authorities and other agencies in charge of controlling goods at the border. With more individual shipments to be cleared and inspected at customs, workloads are growing, stretching the capacity of border authorities to catch illicit goods or properly identify fraud concerning the goods’ value. Risk assessment strategies may also be more difficult to implement.

Better targeting of shipments needs to allow the border agencies to catch offending items while preserving the flow of legitimate trade. Such targeting could include differentiating between low and high-value consignments, identifying trusted traders, and harnessing cross-country co-operation to assess risks, including that relying on better use of digital technologies. Advanced electronic cargo information and automated risk assessment already support border control efficiency today, while big data and pattern recognition may offer additional non-intrusive paths.[7]

Market-land digital tax or world-wide corporate tax

In the digital, and especially in the platform model of the economy, the volume of demand, i.e., the size of consumer/user markets, is becoming increasingly more important for the process of creating added value and making profits. This feature, however, puts traditional taxation policy in front of a new challenge. It is particularly easy for cross-border active digital corporations, e.g., Microsoft, Google, Facebook, Amazon, Apple, and Netflix, to shift their profits, which they make from large markets with many users to where taxes are low because they can serve a market without a physical presence, thus locating their headquarters in so-called tax havens, e.g., Ireland within the EU common market.

For this reason, the European Commission is still considering the introduction of a 3 percent digital tax, based on the market-land principle, on sales generated through online advertising, on the sale of user data, and on the provision of online marketplaces. It is estimated that such a tax can bring EUR 3 to 4 bln of new tax revenues.[8]

The G20 states have also agreed to strive for a worldwide minimum corporate tax and to re-regulate where profits of multinational companies are taxed. In the future, the location of the company headquarters should be less decisive. Instead, a “market land principle” could be introduced, which taxes profits according to where the consumers or users of services of these companies are located.

At the same time, the digital tax and market-land taxation principles received some significant criticism. Firstly, the introduction of a digital tax is likely to lead to retaliatory measures in the form of penalty tariffs. Secondly, all export-oriented economies are likely to suffer if the market land taxation principle is implemented globally. Thirdly, as stated above, large digital economy players generally spend more on research than other companies. Tax breaks may therefore be a more justifiable measure to support corporate R&D than new tax burdens.[9] Instead of a new digital tax, double taxation agreements between countries could be better coordinated to tackle tax avoidance practices.

A potentially effective way to tax de minimis trade could be an approach, in which the national tax authority obliges a foreign e-commerce platform to independently add VAT on all goods sold into the country, provided that the platform, in aggregate, imports a volume of goods and services above a certain value threshold.[10]

The platform corporations of the digital era can be compared to the British maritime trade monopolies of the 18th century or the American oil tycoons of the 19th century. On the one hand, they play an important pioneering role. On the other hand, they too have to give way to free competition and orderly market rules at some point.

Notes:

[1] ifo Institut (2020). E-Commerce. URL: https://www.ifo.de/branchenatlas/e-commerce

[2] Eurostat (2021). Internet purchases by individuals (until 2019). URL: https://appsso.eurostat.ec.europa.eu/

[3] UPS Europe & Statista (2020). European eCommerce Monitor 2020. URL:

[4] Visual Capitalist (2018) This Chart Reveals Google’s True Dominance Over the Web. News. URL: http://www.visualcapitalist.com/this-chart-reveals-googles-true-dominance-over-the-web/

[5] Chazerand P. (2019) Trade will never be the same. DIGITAL EUROPE. IIASA workshop presentation. URL: https://www.iiasa.ac.at/web/home/research/eurasian/PatriceChazerand_InEurasia_Dec2019.pdf

[6] Meltzer J.P. (2018) The impact of artificial intelligence on international trade. The Brookings Institution. URL: https://www.brookings.edu/research/the-impact-of-artificial-intelligence-on-international-trade/

[7] Moise E. (2019) Parcels trade: The good, the bad, and the ugly? OECD. URL: https://www.oecd.org/trade/parcels-trade-good-bad-ugly/

[8] ifo Institut (2018) Die Besteuerung der Digitalwirtschaft: Zu den ökonomischen und fiskalischen Auswirkungen der EU-Digitalsteuer. URL: https://www.ifo.de/DocDL/Studie-Digitalsteuer-2018.pdf

[9] Fuest C. (2018) Digitalisation should be promoted, not taxed. EconPol Europe. URL: https://www.econpol.eu/opinion_12

[10] Kofner Y. (2020). Digital transformation: Implications for trade policy and economic integration. IIASA. URL: http://pure.iiasa.ac.at/id/eprint/16723/

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