Embracing Digital Technology for Accelerating Growth
Author: Mostafizur Rahaman Sohel
2018-03-15, Advanced ERP (BD) Ltd
Digital technology creates opportunities to accelerate growth, but these are often missed because firms in sectors where technology’s impact is the greatest are frequently protected from innovative competitors. Firms that face more competition use digital technology more intensively and effectively—it enables them to reduce their costs to outperform their competitors.
Firms across the world are becoming more connected. For instance, the share of firms with at least five employees using broadband internet in lower-middle-income countries rose from 39 percent to 68 percent from 2006–09 to 2010–14. And the growth rates and valuations of internet firms across the world are surging. Less visibly, but more importantly, digital technologies have transformed traditional production structures, facilitating new, more cost-effective processes. Indeed, most of efficiency gains emerge outside the information and communication technology (ICT) sector, where firms use the internet to sell and market their products online or share real-time information with suppliers to minimize their inventory and with customers to optimize their services.
The impact of digital technology on economic growth is mediated through three mechanisms — inclusion, efficiency, and innovation. It promotes the inclusion of firms in the world economy by enabling more firms to trade new products to new destinations. For instance, firms selling their goods online through Alibaba, China’s leading e-commerce company, are smaller and younger and export more products to different destinations than firms selling offline. It raises efficiency by allowing firms to make better use of their capital and labour. For instance, real-time data help equipment manufacturers in China turn-over their inventory stocks five times faster than suppliers not connected to the internet. It enhances innovation by enabling firms to exploit scale effects through online platforms and services that compete with conventional business models in retail, transport, lodging, and banking, to name a few. These three mechanisms thus boost growth by expanding trade, increasing capital and labour utilization, and intensifying competition.
But the benefits are neither automatic nor assured. Despite great opportunities, firms’ use of digital technologies differs substantially across countries due to variations in skills and infrastructure and barriers to competition and market entry. Harnessing the full growth potential of digital technology is thus predicated not just on investments in skills and infrastructure but also on reforming regulatory barriers by overcoming vested interests to encourage all firms to compete by investing in these modern technologies. This also involves overhauling regulatory regimes in the digital economy, especially in sectors where online and offline firms increasingly compete, such as retail, transportation, printing and publishing, lodging, and finance. The initial entry of internet firms into these sectors promotes competition and can disrupt traditional monopolies. But internet firms can be prone to anticompetitive behaviours by exploiting scale and network effects. The greater digital adoption therefore needs to be accompanied by unified standards, full interoperability, and competition across platforms and contracts.
The goal is to have firms’ use of the internet promote competition, which encourages more firms to use the internet. But that will not happen if vested interest groups are strong enough to capture regulators and create new barriers to competition and technology adoption. A level playing field for business was always important—digital technologies have made it an imperative.
The accumulation of ICT capital accounted for almost 24 percent of global growth between 1995 and 2017, growth accounting approaches suggest. However, the results need to be regarded with some caution, as the approach involves some severe measurement problems. Firms in developing countries have considerable room to adopt digital solutions that have led to growth in high-income countries, such as using the internet for e-commerce or inventory management. The true contribution to growth can be larger if ICT complements other production factors, but also smaller if it substitutes for them.
Assessing the growth opportunities of the internet warrants more detailed analysis of the mechanisms for it to affect growth. Against this background, it is instructive to draw insights from the economics of the internet as well as from the past industrial revolutions. The internet reduces transaction costs, allowing firms to enter new markets, enhance their efficiency, and exploit economies of scale, leading to innovation. It does this by reducing information frictions, search costs, and the costs to communicate. The decline can be dramatic if firms adapt their business models to automate data-intensive transactions, generating economies of scale.
To purchase any product, the buyer must find a seller, make a payment before receiving the goods, and trust that the seller will deliver the correct amount and quality on time. Because of these information asymmetries, only the most productive firms export—typically the larger and older firms. Online marketplaces help solve all three problems. They provide an organized marketplace for firms to advertise their products and find buyers in overseas markets. They thus reduce the costs of trade by enabling firms to avoid intermediaries to establish trade connections or participate in costly trade fairs to market their products. Online marketplaces also include rating systems, allowing the buyer and seller to assess each other’s performance. The ratings and individual comments, visible to anyone, build trust for future transactions and encourage more responsible behaviour. Many online marketplaces also provide payment and delivery services to reduce the cost of e-commerce. Digital technologies also lower communication costs facilitating the unbundling of tasks, allowing firms to offshore production processes and services to developing countries at lower costs.
The internet makes it easier to reach new markets and thereby increases the extensive margin of trade— more firms start to export, and more products get exported. The impact of the internet is largest if both countries have high internet use. Online platforms allow smaller firms to become exporters. The firms selling on eBay in are younger and have smaller market shares than firms in the offline markets. The Alibaba platform has a larger fraction of small firms than the offline market. Firms exporting through Alibaba also sell more products per firm. Online platforms enable firms to reach new export destinations, changing trade patterns. Marketing goods globally on the internet is cheaper and customizing the marketing information to suit the local context and language is easier. So, firms trading through online platforms can reach more destinations than their offline peers.
Digital technologies help firms save costs by automating data-intensive production processes and reorganizing their business models, increasing their productive use of capital and labour. Computers and software allow firms to routinize processes, increasing management efficiency and replacing personnel with, for instance, human resource or supply chain management software. The internet further increases the opportunities for cost saving by connecting machines, suppliers, and clients, so that firms can manage their supply chains and inventory more effectively in real time. The extent to which digital technologies raise labour productivity depends on firms’ activities, but examples abound across countries and economic sectors. Most of efficiency gains emerge outside the ICT sector, where firms use the internet to sell and market their products online or share real-time information with suppliers to minimize their inventory and with customers to optimize their services. Less visible but more important for growth, incumbent firms in traditional sectors invest in digital technologies to save costs by optimizing their production and management processes. Retail companies such as Walmart, for instance, have integrated (global) supply chains to minimize their inventory holdings by linking electronic cash registers at retail outlets and business-to-business ordering systems with order dispatch and transportation scheduling at remote factories. So far, the largest efficiency gains from firms using digital technologies have been found in wholesale and retail trade, business services, insurance, finance, and selected manufacturing sectors. The following section highlights selected illustrations of how digital applications boost firms’ efficiency.
To conclude precisely, developing countries with an institutional environment that safeguards competition and easy market entry will more likely to harness the full growth opportunities of digital technologies and catch up faster with high-income countries. But countries will more likely to remain poor if the institutional environment allows firms to obtain profits by lobbying for protection rather than investing in new digital technologies. Looking around the world, we can see Uber, the world’s largest taxi company, ownsno vehicles. Facebook, the world’s most popularmedia owner, creates no content. Alibaba, the mostvaluable retailer, has no inventory. And Airbnb, theworld’s largest accommodation provider, owns noreal estate. Something interesting is happening. It’s high time for us for embracing the technology as much as we can.
Mostafizur Rahaman Sohel, Managing Director, Advanced ERP (BD) Ltd, Director (2016-18), BASIS.
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