Good day, Mr. Chairman and committee members, and thank you very much for the invitation to be here.
As the managing director of the Canadian economic analysis department of the Bank of Canada, I'm happy to present our views and observations regarding the declining competition in advanced economies. I'll also address the implications for both competition and the longer-term dynamism of the economy related to the emergence of large tech firms as well as the growing importance of big data.
Understanding the impact of digitalization on the Canadian economy is crucial as we seek to achieve our objective of low, stable and predictable inflation. The Bank of Canada does not have a regulatory role with respect to the privacy of citizens' data so I trust you will understand that I will not be able to address the privacy implications of these issues.
The Canadian economy is digitalizing rapidly. Digital disruption is expected to be positive for economic progress overall. New firms are being created and existing ones are being transformed as new technologies change the way businesses operate. For consumers, digitalization means that households can purchase a seemingly ever-widening range of goods and services 24-7 from around Canada and from around the world.
Digitalization will contribute to higher productivity, and hence higher living standards, in the coming years and decades.
There is a lot of concern about the rise of the robots and how they could take away people's jobs. Naturally, we tend to focus on these initial effects. But we also need to be mindful that it takes a long time to fully replace a worker with a robot.
Still, there is no doubt there will be disruption for some, and there is time for society to adjust. People whose jobs are affected will need support. Job training and a strong safety net are key.
We must also remember that digitalization is creating new kinds of jobs and will create some that haven't even been imagined yet. These new jobs will help the economy grow. New jobs mean new incomes, which will be spent not just in the digital economy but across the whole economy, with benefits for workers in traditional jobs too.
One of the driving technologies of digitalization is the application of artificial intelligence and machine learning in conjunction with big data to a wide range of business applications. AI and ML increase firms' productivity in three major ways. First, AI and ML help companies make better products and improve their customers' experiences. Second, they help develop products and services more efficiently and more quickly. Finally, they help firms reach new markets and customers.
There are practically countless examples of such applications.
They include farmers using GPS autopilots to drive their tractors and optimize fertilizer and pesticide use; robots working on factory floors and in warehouses, "driving" forklifts to move goods and digitally track them from supplier to retailer; Al offering up suggestions for products or services you may wish to buy; and having chatbots and robo-advisers standing ready to answer your questions when you visit websites.
By implementing AI and ML with big data, firms can gain a competitive advantage, ultimately through offering a better product or service at a lower price. One of the features of AI and ML, big data and network effects is that there are often significant benefits in being a first mover. In fact, market concentration happens quite naturally in industries with prominent network effects and other scale economies.
In the current environment, this dynamic can lead to the creation of superstar firms. These firms tend to have fewer employees than conventional companies and they often earn impressive monopoly profits.
What is new is that the winner-takes-all effect is magnified in the digital economy because user data has potentially become another source of monopoly power. Data from a large network creates a formidable barrier to entry in some cases. Another barrier to entry can come from firms using the position as gatekeepers of crucial online services to impede their competitors and thwart innovation. In this context, we believe competition policy can be modernized appropriately to help ensure that benefits of digitalization are fully realized.
What do we know? What evidence do we have on the issue of market concentration, markups and prices?
In recent years, economists have paid considerable attention to the secular rise of market concentration in advanced economies. In particular, models have been developed that tie this rise to digitalization. Specifically, these firms are able to capture an increasingly large share of the market because of technological advances, such as AI and ML with big data, thereby increasing concentration. They also have a high share of profits, which can lead to a fall in the labour share of income.
Overall, most industries have seen an increase in their concentration over the last 15 years. Although the evidence is not conclusive, a broad increase of industry concentration across countries suggests that technological change, that is, digitalization, rather than country-specific factors, is perhaps the main driver.
One concern in an environment dominated by superstar firms is that those firms have more power when setting prices, which could lead to an increase in prices. That's why economists have also been looking at the secular rise in market power of firms as measured by markups. For example, researchers documented a rise in average markups in the U.S. from 1980 to 2014. They also found that global markets have risen as well. This increase is also observed in Canada. For Canada, they document a very similar overall trend to the U.S., a finding confirmed by the IMF. This suggests that market power's been rising in many countries over the past few decades.
The next question is whether digitalization has affected consumer prices. This is often referred to as the “Amazon effect”, where competition from digital retailers results in lower prices. It may appear inconsistent that digitalization can lead to both higher markups and lower prices. However, it is simply that the benefits of technology partly go to the customer in the form of lower prices, but also to the firm in the form of higher markup over lower cost.
While the direct evidence of the impact of digitalization on inflation is mixed, it does tend to point to downward pressure overall. In a research paper published last year, bank staff found that the direct evidence pointed to a small negative impact of digitalization on inflation. That is, digitalization was weighing on price increases rather than feeding them. Evidence using online prices data, such as the Billion Prices Project, is mixed. Some find that online prices tend to behave similarly to bricks-and-mortar store prices, while others find big effects on inflation year over year on the downward side. Most of us are familiar with why this might be happening—our ability to check competitor's prices using our smart phones before we head to the checkout.
Finally, when using the framework upon which the bank's main economic models are built to assess the channels through which digitalization may affect inflation, we find that most developments associated with digitalization would put downward pressure on inflation.
Overall, the impact of digitalization on market concentration, and hence competition, remains an open question. The bank will continue to examine the impact of digitalization on the Canadian economy as we pursue our objective of promoting the economic and financial welfare of Canada.
Thank you once again for the invitation to appear.