Uniform Commercial Environment

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The European Union's directive on personal data illustrates the need to have a global (not regional) perspective in securing a workable commercial environment for electronic commerce. A uniform commercial environment for the global information infrastructure (GII) has more to do with setting ground rules than erecting or removing artificial barriers.

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However, a uniform commercial environment for the GII must represent international standardization and national interests to promote economic well-being. The question is whether a uniform law or regulation can avoid having differential impacts on individual countries. For example, using a closed-economy model of trade, countries leverage tariffs and income-tax policies to manipulate economic performance. However, a uniform import/export tax—such as no tax, making all Internet transactions duty-free—implies an open international economy that may result in the loss of policy control over domestic economy. Domestic industries are often protected by high tariffs, and a country's balance-of-payment position depends on selectively controlling exports and imports. Many countries may not accept simple uniformity if it means relinquishing this tool.

According to the U.S. and the European Union, the principal approach to achieving a healthy GII is to rely on the market (IITF 1996; European Council, 1994). However, a uniform commercial environment can only be achieved through widespread international negotiation and cooperation, of which there has been scant evidence. Several exceptions exist in the areas of copyright, key encryption, and electronic contract standards. But, even in these areas, the uniformity underlying these efforts is procedural rather than specific. That is, the goal is to lay a framework within which governments can verify, recognize, enforce, and promote international transactions.

In addition to the World Intellectual Property Organization's (http://www.wipo.org) worldwide conference on copyright (see Chapter 5), the Working Group on Electronic Commerce of the United Nations Commission on International Trade Law (UNCITRAL)

(http://www.un.or.at/uncitral/mainindx.htm) published its Model Law on Electronic Commerce (excerpt available at

http://www.un.or.at/uncitral/texts/electcom/english/ml-ec.htm), which establishes a uniform framework to establish the legal validity of electronic documents in commerce. The Model Law, adopted in 1996, sets standards for electronic equivalents to paper-based terms such as writing, signature, and original. Although UNCITRAL has been working on international standards for physical goods trading for more than three decades, such

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international bodies will need to take on an increasingly important role, and also will need to be taken more seriously, in global electronic commerce.

Another prime area of international policy interest is cryptography. As mentioned earlier, policies regarding encryption technologies are first and foremost affected by national security interests. Imagine, then, the Internet filled with private conversations, encoded with unbreakable encryption. Besides crimes and conspiracies that might be discussed, the normal process of information gathering by governments would be severely limited.

One method of managing encryption technology requires all keys to be archived or escrowed with a trusted third party. The archived keys would be used to break or recover encrypted messages. Managing such a key escrow system involves a certification authority that issues the keys, a trusted third party to archive such keys, and an infrastructure to provide the necessary confidentiality and accountability when governments want to access these keys on legitimate grounds. At present, the widespread use of encryption technologies is discouraged by the lack of technology to integrate encryption into applications, rather than by any impediments imposed by policy (Denning, 1997).

A global key escrow system is proposed mainly to balance law enforcement and national security concerns with the need to facilitate private communications and transactions on a global scale. Nevertheless, the OECD (http://www.oecd.org) adopted in March 1997 its Guidelines for Cryptography Policy without specifically endorsing such an international key escrow system. No matter what systems are supported in the market, however, continued international cooperation is imperative to achieve an interoperable encryption system because digital signatures, public keys, and encrypted digital currency are essential in providing identity, confidentiality, nonrepudiation, and other basic commercial requirements in the GII.

The global nature of the Internet is clearly one of its strengths, but a predictable international legal and commercial environment is lacking. Recent agreements negotiated by the World Trade Organization (http://www.wto.org) lay a solid foundation for global electronic commerce (see the sidebar, "WTO

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Agreements"). The urgency to establish an international framework will grow as digital products become the commodity of the GII, which today remains largely a communications medium. While governments have some credible needs to control free exchanges of ideas—whether they be sociocultural or political reasons—restricting commercial transactions on the GII will have severe economic consequences.

WTO Agreements

Two recent agreements sponsored by the World Trade Organization have set up a global market in telecommunications, computers, and software—helping to remove tariffs and increase worldwide competition among high-technology firms.

(1) Basic Telecommunications Agreement

In February 1997, 69 WTO members signed the WTO Agreement on Basic Telecommunications Services, which will go into effect on January 1, 1998 as part of the General Agreement on Trade in Services. The Agreement concerns only basic telecommunications services, excluding value-added services such as online data services. Signing parties to the Agreement commit to

"negotiate on all telecommunications services both public and private that involve end-to-end transmission of customer supplied information (for example, simply the relay of voice or data from sender to receiver. They also agreed that basic telecommunications services provided over network infrastructure, as well as those provided through resale (over private leased circuits), would both fall within the scope of commitments. As a result, market access commitments will cover not only cross-border supply of telecommunications but also services provided through the establishment of foreign firms, or commercial presence, including the ability to own and operate independent telecom network infrastructure. Examples of the services covered by this agreement include voice telephony, data transmission, telex, telegraph, facsimile, private leased circuit services (that is, the sale or lease of transmission capacity), fixed and mobile satellite systems and services, cellular telephony, mobile data services, paging, and personal communications systems."

The basic telecommunications industry is a $600-billion-a-year industry. Table 11.1 shows the sizes and shares of the top 10 markets. In comparison, world trade in agriculture totaled $444 billion, automobiles $456 billion, and textiles $153 billion in 1995.

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Table 11.1World Trade Figures

Revenues in Share of Millions (U.S. Dollars) Percentage of Share

Table 11.1World Trade Figures

Revenues in Share of Millions (U.S. Dollars) Percentage of Share

United States

178,758.0

29.70

EC (European Community) 170,166.0

28.27

Japan

93,855.0

15.59

Australia

11,403.0

1.89

Canada

10,689.0

1.78

Switzerland

8,889.0

1.48

Korea

8,728.0

1.45

Brazil

8,622.0

1.43

Mexico

6,509.0

1.08

Argentina

6,009.1

1.00

(2) The Information Technology Agreement

WTO's Information Technology Agreement aims at reducing customs duties on computer and telecommunications products beginning July 1, 1997, and eliminating them altogether by the year 2000. This agreement will also affect the $600 billion market that includes computers, software, telecommunication products, and semiconductors.

Categories of products covered by the agreement include:

1. Computers (including complete computer systems and laptops as well as components, such as CPUs, keyboards, printers, display units (monitors), scanners, hard-disk drives, power supplies, and so on)

2. Telecom equipment (including telephone sets, videophones, fax machines, switching apparatus, modems and parts thereof, telephone handsets, answering machines, radio-broadcasting and television transmission and reception apparatus, and pagers)

3. Semiconductors (including chips, wafers, and so on, of various sizes and capacities)

continues

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continued

4. Semiconductor manufacturing equipment (including a wide variety of equipment and testing apparatus used to produce semiconductors, such as vapor deposition apparatus, spin dryers, etching and stripping apparatus, laser cutters, sawing and dicing machines, deposition machines, spinners, encapsulation machines, furnaces and heaters, ion implanters, microscopes, handling and transport apparatus, measuring and checking instruments, and parts and accessories)

5. Software (contained in diskettes, magnetic tapes, CD-ROMs, and so on)

6. Scientific instruments (including measuring and checking devices, chromatographs, spectrometers, optical radiation devices, and electrophoresis equipment)

Additionally, other main products of interest covered by the ITA include word processors, calculators, cash registers, ATM machines, certain static converters, indicator panels, capacitors, resistors, printed circuits, certain electronic switches, certain connection devices, certain electric conductors, fiber-optic cables, certain photocopiers, computer network equipment (LAN and WAN equipment), flat panel displays, plotters, and multimedia upgrade kits. The ITA does not cover consumer electronic goods.

11.9. Antitrust and Regulation Policies

In the interest of promoting competition and efficiency, governments often intervene in the marketplace. Antitrust laws and regulatory policies aim to promote market efficiencies, such as low prices and efficient resource allocation. Antitrust laws ensure efficient results by safeguarding the market from anticompetitive behaviors such as price-fixing conspiracies, predatory pricing, and competition-reducing mergers. Regulation focuses on markets in which the nature of a product or industry tends to favor a single firm and competition usually results in inefficiencies. In such markets, promoting competition would not be efficient, that is, would not bring about lower prices and more output. Such firms are called natural monopolies, and their regulation should

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be distinguished from other governmental regulations of wages, environments, safety, and so on.

Anti-regulation and anti-antitrust sentiment has been high since the 1980s. This sentiment stems from antitrust litigations that were largely ineffective or dragged on for decades without yielding clear guidelines for market participants. Also, it has been argued that regulated firms could subvert the regulatory process, for example, by influencing regulators, whereby firms were protected from competition with no apparent gain in efficiency. An alternative is to depend on market mechanisms. But the nature of digital products poses a severe problem in defining anticompetitive behaviors. For example, how do you determine that a digital seller is dumping or practices predatory prices when all products have essentially the same marginal cost? How do you distinguish the need for interoperability and standardization from monopolization? And should all digital products be regulated because they have economies of scale and allow only one firm to operate for efficiency reasons? Two factors seem to favor a single dominant firm in each digital product market: the economy of scale and interoperability.

Economies of Scale and Regulation

Economies of scale refer to gains or losses in production cost that occur as output is increased. Typically, production costs first decrease because fixed costs such as buildings and management expenses are shared. They then increase as inefficiencies kick in when the output level goes beyond the optimal level. For example, suppose a firm has ten permanent employees who can each produce ten widgets a day given the layout of the factory, materials, and so on. The salaries and other costs, such as office rent, must be paid whether the firm produces anything at all. The per-unit cost of the first widget produced is the sum of all these costs, which decreases until 100 units are produced a day. For the 101st unit, one employee may have to work overtime, the firm may have to pay special delivery charges to its material suppliers, or a new machine may need to be purchased. The average cost of a widget increases rapidly beyond the optimal level of production.

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A simple case of decreasing average cost occurs when there is a high fixed cost but no (or constant) variable cost. Because the fixed cost is shared by more and more output, the average cost will decrease forever. It is commonly asserted that computer software costs nothing or little to duplicate. Development costs account for the majority of the software's production cost. Consequently, the average cost of a computer program will drop as more copies are sold. Similarly, most digital products appear to have economies of scale.

When a product has a decreasing average cost or an increasing economy of scale, the market often fails to achieve an efficient solution. Competition implies duplicated fixed costs, and no firm could recoup its fixed costs unless the market price equals the average cost. Without such guarantee, no firms will produce the product. Does this imply that all digital products should be regulated as natural monopolists?

Digital products may not have economies of scale for two reasons. First, computer software, and most digital products for that matter, may not have decreasing average costs. Although duplicating costs may indeed be relatively small compared to initial development costs, duplication costs are not the only variable costs for most products. Many physical products have low variable costs—for example, cereals, sneakers, and so on—but they do not have decreasing average costs, because variable costs (such as administrative, marketing, and distribution costs) increase at a faster rate as the number of sales increase (Liebowith and Margolis, 1995). For this reason, many digital products will have U-shaped average costs (see Chapter 8 for more detail about costs). Furthermore, for each copy of software or information sold, other substantial costs may exist, for instance, copyright payments and copyright enforcement costs, customer support expenses, and management and accounting costs. As a result, whether digital products exhibit decreasing average costs remains an empirical question.

Second, economy of scale is not as relevant when products are not homogeneous. The economy of scale simply indicates that having one producer is more efficient if you consider all varieties as essentially the same. For

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