Economics Of Digitization

The economics of digitization. Honestly. You want me to dissect that? Fine. But don't expect enthusiasm. It's a field that studies how the relentless march of digitization, digitalization, and digital transformation grinds away at markets, and how we can use digital data to dissect it all. Digitization, in its glorious simplicity, is the process where technology just… lowers the cost of doing things. Storing, sharing, analyzing data. It's rearranged how consumers act, how industries are structured, and how governments stumble through their days.

This isn't just a sub-branch; it's a whole new landscape because the digital world is… well, it’s digital, it’s exponential, and it’s combinatorial.

First, traditional economic models? They’re useless. Digital goods have marginal costs so low, they might as well be zero. Your old assumptions? Dust.

Second, the pace. Computers, networks, the whole digital engine. It’s improving exponentially, like some kind of relentless, digital Moore's Law.

Third, these digital things. They can be mashed together, recombined, creating value not just through networks and platforms, but through entirely new, absurd combinations. Each aspect is significant. Together, they form something… else. A distinct economic terrain.

Research in this area bleeds into industrial organization, labor economics, even intellectual property. Much of it orbits the idea that current regulations on copyright, security, and antitrust are just… quaint. Take information goods, like that article you’re pretending to read. Zero marginal cost for production and distribution. Which, naturally, makes redistribution without permission commonplace and competition a brutal, messy affair. The research here is about how policy can even attempt to keep up.

It’s new. The National Bureau of Economic Research only bothered with its first workshop on the Economics of Information Technology and Digitization in 2011. Topics? Digital advertising, digitization and productivity. Groundbreaking.

Information Technology and Access to Networks

Technological Standards

The Internet. A layered beast, run by a chaotic consortium of participants. It's not just one thing; it's a jumble of standards, networks, and web applications – streaming, file-sharing – all clinging to networking technology. The Internet's rise coincided with a new organizational structure: the standards committee. [4] [5] These committees, populated by industry, academia, and various non-profits, are tasked with creating the critical standards – TCP/IP, HTML, CSS. Their aim? Advance technology while ensuring everything still talks to everything else. Economists are fascinated by their decision-making processes. And whether those decisions are, you know, optimal.

The Supply of Internet Access

The commercial free-for-all of Internet access began when the National Science Foundation decided commerce was acceptable. The 90s saw a proliferation of regional and national Internet service providers (ISPs). By 2014, however, high-speed broadband had become a bit of a boys' club. Around 80% of Americans can only get 25 Mbit/s from a single provider. A majority have a choice of only two for 10 Mbit/s service. Economists are particularly drawn to the competition dynamics and the pervasive network effects here. [6] And then there's the broadband availability itself, which can subtly shift the relative wages of skilled versus unskilled workers. [7]

Demand for the Internet

A central question in the economics of digitization: what’s the actual value of these Internet-based services? It’s twofold. First, understanding policies related to network infrastructure and subsidies. Second, trying to quantify the gains consumers actually get. The revenue of ISPs is one blunt measure of the digital economy's growth. [8] [9] But it’s crucial because traditional measures like GDP likely understate the true benefits of technological progress. This modern digital economy also has a tendency to rely on inputs that cost nothing. [10]

The Effects of Digitization on Industrial Organization

Platforms and Online Marketplaces

Digitization has brought platforms and marketplaces to the forefront, connecting disparate agents in both social and economic spheres. A platform, as defined by Bresnahan and Greenstein (1999) [11], is "a reconfigurable base of compatible components on which users build applications." They're defined by their technical standards – the engineering specifications for hardware, the software protocols. The pricing and product strategies of platforms diverge from traditional firms due to network effects. The participation of one group impacts the utility of another. Many online platforms can replicate processes and algorithms infinitely, scaling network effects without diminishing returns. This makes analyzing competition between them far more complex than with traditional firms. A significant portion of the research grapples with how these entities operate, how they compete, and whether their tendency towards "winner-takes-all" outcomes warrants antitrust intervention. [12] [13]

Online platforms often slash transaction costs, particularly in markets where the quality of a good or trading partner is uncertain. [14] Take eBay. It vastly expanded the market for used goods with its search engine, reputation system, and other risk-reducing features. Other examples include Airbnb for lodging, Prosper for loans, and Odesk for labor. Economists aim to quantify the gains from these marketplaces and explore optimal design. Many, like eBay and Odesk, have adopted auctions as a selling mechanism, fueling a substantial body of work on the comparative advantages of auctions versus fixed prices. [15] [16] [17] [18]

User-Generated Content and Open Source Production

Advertising

Advertising is a critical revenue stream for information goods, both online and offline. Given its prevalence online, understanding online advertising is paramount. Economists have dedicated considerable effort to quantifying its returns. A particularly fascinating aspect is its ability to target consumers using granular demographic and behavioral data. [26] This capability could influence the ability of new and small firms to reach customers and grow. Targeted advertising is controversial, often utilizing private data acquired from third parties. Quantifying the costs and benefits of such data usage remains an active research frontier.

The Effects of Digitization on Consumer Choice

Search, Search Engines, and Recommendation Systems

Perhaps the oldest and most substantial line of research on the Internet and market frictions centers on reduced search costs. This builds on earlier economic theories [27] [28] [29] that explored how search costs influence prices. The digitization of retail and marketing meant consumers could easily compare prices across different stores, leading to empirical work examining the impact on prices and price dispersion. Initially theorized by Bakos (1997), [30] the first wave of research documented lower prices, though still with considerable dispersion. [31] [32] [33]

The latest wave collects data on online searches to dissect the actual search process consumers undertake. [34] [35] This also highlights how the final purchase is often dictated by familiar retail environments, raising questions about the increasing importance of standards and platforms in distributing creative content.

As mentioned, the near-zero marginal costs for distributing information goods can alter consumption patterns. Geographic barriers may become less significant if information travels freely over long distances. [36] [37] [38] One lingering question is how the benefits of these low distribution costs are distributed. They might vary by location, with areas lacking offline options potentially seeing greater gains from digitization. [39] [40]

Moreover, online retailers of digital goods can stock an almost infinite variety of products without inventory concerns. Even a song selling only a few times can remain profitable. Simultaneously, zero marginal distribution costs mean that "superstar" items never go out of stock, potentially achieving even higher sales (Anderson, 2006). Several studies attempt to quantify the economic impact of this increased product variety facilitated by electronic markets. [41] [42] Bar-Isaac et al. (2012) [43] offer a theoretical framework for when lower search costs lead to "superstar" and "long-tail" effects.

Reputation Systems

A particularly crucial aspect of digitization for consumers is the proliferation of reputation systems on retail sites and online marketplaces. A Nielsen survey in 2013 found 68% of respondents trusted online reviews. Numerous studies demonstrate that these systems influence consumer demand for restaurants, [44] books, [45] and hotels. A key research area investigates whether online reputations accurately reflect both the vertical (quality) and horizontal (features) aspects of a good. For instance, Forman et al. (2008) [46] found that local reviews carry more weight than those from distant reviewers, suggesting they provide information on both vertical and horizontal differentiation. Conversely, other research indicates online reviews can be biased due to selective participation, [47] fear of retaliation, [48] or sellers promoting their own products. [49] Newer research proposes designs for reputation systems that aggregate user experiences more effectively. [50]

The Effects of Digitization on Labor Markets

Digitization has, in some cases, fully replaced human labor, while in others, it has made workers significantly more productive. Economists are keen to understand how these forces shape labor market outcomes. A substantial body of research examines skill-biased technical change, where technology boosts wages for educated workers. Conversely, Autor (2014) [51] presents a framework for categorizing jobs based on their susceptibility to computer replacement. Furthermore, the productivity gains from information technology are contingent on complementary organizational changes. Garicano and Heaton (2010) [52] observed that IT only enhanced police department productivity when coupled with increased training and support staff. Bresnahan, Brynjolfsson, and Hitt (2002) [53] found evidence of organizational complementarities with IT, driving demand for skilled labor.

Digitization has also drastically reduced communication costs between workers across organizations and locations, altering the geographic and contractual organization of production. Economists are interested in the scale of this shift and its impact on local labor markets. One study found that the potential for manufacturing jobs to be offshored did not reduce US wages, though survey data suggests 25% of American jobs are potentially vulnerable in the future. [54]

Online labor market platforms like Odesk and Amazon Mechanical Turk represent a distinct form of labor production stemming from digitization. Economists studying these platforms investigate their competitive and complementary roles with traditional firms. Another active research area focuses on incentivizing greater worker efficiency on these platforms. [55] While routine, lower-skill tasks are particularly susceptible to competition from online labor markets, creative professions are also impacted as platforms increasingly offer avenues for crowdsourcing creative work.

Government Policy and Digitization

Intellectual Property and Digitization

A primary policy concern regarding digitization revolves around intellectual property. The rationale for copyright and patent rights is that they incentivize the production and dissemination of intellectual property. However, digitization and ease of copying have made defending these rights, particularly copyright, exceedingly difficult. Varian (2005) [56] offers a theoretical framework for viewing this shift from an economic perspective. While the economic impact on copyright holders from free copying is typically seen as negative, Varian argues that if a consumer's value for the right to copy exceeds the reduction in sales, a seller can profit by allowing it. He also details various business models that can address the challenges of enforcing copyrights in an increasingly digitized world. Alternative models include selling complementary goods, subscriptions, personalization, and advertising.

Empirical research in this domain examines the effects of Internet file-sharing on the supply and demand for paid content. Danaher et al. (2010) [57] found that removing NBC content from iTunes led to an 11.4% increase in illicit copying, suggesting licensed and unlicensed content are substitutes. Giorcelli and Moser (2014) [58] demonstrated that the spread of copyright in Italy between 1770 and 1900 spurred the production of new and improved operas. Nevertheless, there's a scarcity of research on how these empirical findings should inform copyright rules and security practices.

Net Neutrality

• Main article: Net neutrality

Privacy, Security, and Digitization

Privacy and data security are areas where digitization has significantly altered costs and benefits for various economic actors. Traditional privacy policies focused on limiting government access to individual data. However, the immense capacity of firms to collect, process, and analyze granular consumer data has shifted the policy focus towards regulating firms' access to consumer data. Theoretical work on commercial privacy often centers on behavioral price discrimination as a framework for modeling privacy concerns. [59] [60]

Goldfarb and Tucker (2011a) [61] authored the first empirical study on the economic effects of privacy regulations on the advertising-supported Internet. Privacy regulations in Europe have made it harder for firms to collect and use browsing data for targeted advertising; field data indicates these policies correlate with a 65% reduction in banner ads' influence on purchase intent. Their research also suggests privacy regulation might unpredictably alter the web landscape, potentially leading to more intrusive advertising and prompting marketers to shift ad spending away from newspapers due to difficulties in finding relevant placements.

Another related concern is the precautions firms should take against data breaches, such as those at Target and Staples. Arora et al. (2010) [62] model firms' security efforts from an economic standpoint, finding that direct competition reduces the time it takes for a firm to patch software vulnerabilities. Other studies measuring the economic impact of information security policies include Miller and Tucker (2011), [63] who examine mandatory encryption policies, and Romanosky et al. (2011), [64] who investigate mandatory breach notification laws.

Other Issues

Numerous other policies related to digitization pique economists' interest. For instance, digitization can affect government effectiveness and accountability. [65] It also facilitates cross-border firm-to-consumer transactions, posing challenges for tax enforcement. [66] Companies with novel, internet-based business models, such as Airbnb and Uber, present regulatory challenges for traditional service providers. Many safety and quality enforcement regulations may become less critical with the advent of online reputation systems. Lastly, digitization is of considerable importance to healthcare policy. Electronic medical records offer the potential for more effective healthcare but introduce complexities for privacy policy. [67] [68]

Books

In May 2015, the National Bureau of Economic Research published "Economic Analysis of the Digital Economy" with the University of Chicago Press, edited by Avi Goldfarb, Shane Greenstein, and Catherine Tucker. This volume gathers leading scholars exploring this burgeoning field. [69] Prior to this, Edward Elgar Publishing released "Economics of Digitization," a compilation of twenty-five significant articles in the area. [70]