Internet in China - Transaction Cost Reduction with Increasing Political Costs

Internet in China – Transaction Cost Reduction with Increasing Political Costs Christian Schmidkonz Duisburg, 21. November 2003

Key Question: Can the economical differences in China be overcome via the Internet? 07.06.09 The Internet can have both a converging and diverging effect on the economic differences in China. Western Provinces Eastern Provinces Converging Effect Diverging Effect Development Gap Monetary Transfer Potential economical influence through use of the Internet

07.06.09 Internet – Transaction Cost Reduction with Increasing Political Costs
Defining the object under examination
Quantifying the diffusion of Internet in China
Influence of institutions on the Internet economy
What institutions mean for the Internet
Institutions that regulate the Chinese Internet
The scope and meaning of the digital divide for the economical divide in China
21. November 2003

The „Internet Economy“ can be viewed as a part of the „New Economy“ 07.06.09 Information Technology & Internet NEW ECONOMY „ Macro View“ Information Technology Internet INTERNET ECONOMY „ Micro View“
The Internet Economy describes economic development that is directly related to the use of the Internet as a platform for economic activity.
Physical networks act as the sole foundation for the Internet economy.
Economical activity can extend beyond e-commerce to encompass infrastructure development, Web portals, consulting and other services.
Economical activity in the Internet economy has an influence on investments, the job market, income, industry structures, GNPs, etc.
The New Economy symbolizes the change assigned to an economic vitality that results from the rapid development and expansion of information technology. Refers to electronic and high-tech sectors such as the Internet, telecommunications, biochemicals and semiconductors.
Markets of the New Economy are typically more dynamic, more global and better networked than the markets of the Old Economy.
As opposed to the diffusion hypothesis , which assigns the economic growth at the end of the 90‘s to a delayed effect from computer use, the Internet hypothesis says that growth can only be attained when computers are connected.

The structure of the Internet economy is divided into four layers that are directly dependent upon one another. 07.06.09 IV. Online Transaction III. Intermediaries Economic Activity Layer I. Internet Infrastructure II. Applications Infrastructure Layer - Only companies that conduct Web-based commerce transactions - Can cross a wide variety of vertical industries - Can include all kinds of online sales (B2B, B2C, B2G)
Companies which are predominantly Internet pure-play (e.g. Web content providers) - Do not directly generate revenues from transactions, but through advertising, membership subscription fees, and commissions. - Significant impact over time on the efficiency and performance of electronic markets.
Software products and services build the necessary basis to facilitate business on the Web - Also includes, consultants and service companies that design, build and maintain websites - Output of this layer is not necessarily tangible to the average Internet user
- Companies in the infrastructure sector are a prerequisite for the WWW - The Internet Infrastructure Layer consists of the telecommunications companies, Internet Service Providers, Internet backbone carriers, “last mile” access companies Note: PC and other hardware markets are not included in this scope of the Internet economy

21. November 2003

The diffusion of the Internet in the USA took place much faster than that of previous media technologies 07.06.09 10 Years 20 Years 30 Years 40 Years Time it took to reach 50 million users in the USA Radio (38 Years) Television (13 Years) Cable TV (10 Years) Internet (5 Years)

The growth rate of Internet users already peaked in early 2000 07.06.09 Internet users in China
Within 5 years, the number of Internet users in China increased 57-fold.
The highest growth rate for Internet users was reached with the changing of the millenium (122.5% at the beginning of 2000).
Half of all Internet users in China are found in Guangdong, Beijing, Shanghai, Jiangsu, Zhejiang and Sichuan alone.

The start of Internet development in China was characterized by a clearly gender-specific digital divide. 07.06.09 Gender-specific digital divide in China
The gender-specific digital divide was reduced by mid-2001, but since then it has stagnated at a constant level.
At the beginning of the Internet age in China, over 90 percent of Internet users were male.
Since mid-2001 the ratio between male and female users online has remained the same at 60:40.

The number of Websites in China increase correspondingly to Internet use 07.06.09 Number of Websites in China
In July 2003 there were nearly half a million Websites in China, most of which were in the Chinese language.
The highest growth rate for Websites in China was registered at the start of Internet development.
Since January 2001, subdomains are also included in the count.

The longest times spent online per week were measured at the beginning of the Internet age in China. 07.06.09 Average time online per week in hours
The time spent online at the beginning of Internet development in China can no longer be attained.
Within two years (2000-2002) Internet use was even reduced by half.
Due to the growing number of offerings, increasing speeds and sinking prices, the time spent online has been increasing in the past years.

Over 90 percent use their personal income for Internet use today. 07.06.09 Average time spent online per week in hours
Sinking prices for Internet use, increasing Internet use at home and growing numbers of non-job related use (as well as non-university related use) lead to the costs being covered more and more by users‘ personal income.
The importance of the „work unit“ (also University) decreased from 35 percent (1998) to 10 percent (2002).

Two thirds of Internet users currently access the Web from home 07.06.09 Where users usually access the Internet, July 2003
The development of the Internet has only minimal effect on where users usually access it.
In October 2003, the Ministry of Culture announced that all 110,000 Internet cafés in the country are to be consolidated by 100 companies, the majority of which are state-run businesses.

Overall, the diffusion of the Internet in China is characterized by a series of typical determinants. 07.06.09 Enablers Bottlenecks
Constantly increasing bandwidth capacities
Internet access provided by Internet cafés
Chinese government‘s fundamental interest in the diffusion of the Internet
Widespread acceptance of the Internet in large cities.
WTO entry creates new global possibilities for trade.
Expensive Hardware necessary
Low Speed
Bad ISP Service
Expensive Usage Rates
Strong Control of Internet Content
Heavy Regulation for Internet Companies
Weak purchasing power of the population especially in the western regions.
The meaning and purpose of the Internet is unclear to many.
The Chinese government generally supports Internet development, particularly for economic purposes, and as long as the „appropriate“ content is published. Due to the unequal intensities of the enabler and bottleneck factors, a digital divide is a possible danger in China.

21. November 2003

The complete institutional structure consists of external, internal and neutral institutions. 07.06.09 EXTERNAL INSTITUTIONS INTERNAL INSTITUTIONS DIFFUSION OF TELECOMMUNICATIONS TECHNOLOGY, INTERNET AND RELATED SERVICES BOTTOM UP Primarily privately-driven diffusion Primarily state-driven diffusion TOP DOWN Gradual influence over time Gradual influence over time NEUTRAL INSTITUTIONS

Through the Internet, institutions can influence the cost of transaction as well as transformation. 07.06.09 I. INSTITUTIONS II. TRANSACTION COSTS Trade V. TECHNOLOGY III. TRANSFORMATION COSTS Production IX. Internet (e.g. E-Commerce) VIII. Internet (e.g. E-Learning) VII. Direct influence on diffusion Indirect influence on height of transaction- and transformation costs VI. Direct influence on height of transaction costs IV. Reduction of total ressources and influence on decision between production vs. exchange E-Commerce E-Learning Infrastructure

Within the Internet diffusion, there are numerous interdependencies between the infrastructure and business/ knowledge layers. 07.06.09 Internet access (Infrastructure) Use of the Internet (Knowledge) Transferability of knowledge (Infrastructure) Use of knowledge (Knowledge)
The following are needed in order for knowledge transfer to take place for the purpose of decreasing transformation and transaction costs:
Internet infrastructure
Knowledge about the use of the Internet
Increase in the capacity of the Internet infrastructure
Path of Diffusion Use of E-Commerce I

The Internet allows not only the electronic communication of data and information, but is the first to communicate knowledge as well. 07.06.09 Data: pure, non-interpretable and non-related signs and symbols Information: data to which a relationship is assigned Knowledge: conclusion based on information Wisdom: future-oriented use of knowledge E-L Data Information Knowledge Wisdom Understanding of Relations Understanding of Patterns Understanding of Principals P ast Future (Object under examination) (Not an object under examination)

Depending on the nature of the product, market participants and transaction, the Internet can play an important role. 07.06.09 physical products physical market participants physical transactions digital products digital market participants digital transactions digital products physical market participants physical transaction physical products physical market participants digital transaction TRADITIONAL MARKET MIXED FORMS ELECTRONIC MARKET E-C

Through the Internet, transaction costs can be decreased in all market transaction phases. 07.06.09 ECE ECE ECE EIE EIE EIE EBE EIE Internet supports search for physical or digital products, e.g. via search engines Payment and shipping take place through the Internet Contact made automatically through the Internet Decisions made automatically, e.g. through lowest or highest price Internet supports search for digital products Electronic market (purely digital transactions, only digital products) Payment and shipping partly via the Internet, or without the Internet, e.g. e-payment Contact made personally or digitally, supported by the Internet, e.g. via contact form Decisions made either offline or with the help of the Internet, e.g. via price comparisons Mixed forms (mixture of physical and digital transactions and products) Not influenced by the Internet Not influenced by the Internet Not influenced by the Internet Not influenced by the Internet Traditional market (purely physical transaction, only physical products) ECE: Electronic Communication Effect EIE: Electronic Integration Effect EBE: Electronic Brokerage Effect E-C Information phase Decision-making phase Agreement phase Closing phase

Potential savings through B2B commerce were already estimated for specific industries in the USA. 07.06.09 Quelle: UNCTAD (2001) E-C Industry Potential cost savings in percent Aviation 11 Chemical 10 Coal 2 Communication 5-15 Computer 11-20 Electronic Components 29-39 Food 3-5 Lumber 15-25 Shipping 15-20 Health 5 Life science 12-19 Machines 22 Media & Advertising 10-15 Maintenance 10 Oil & Gas 5-15 Paper 6 Steel 17

21. November 2003

The 10th Five-Year-Plan explicitly includes the development of the telecommunications sector and a Knowledge-Based Economy 07.06.09
Further describe the government‘s functions and responsibilities.
Strengthen the capability for innovation and accelerate the commercialization of innovations.
Develop human resources
Open further channels for investment.
Increase exports of electronic products
Develop western regions.
Create fair conditions for competition and a level playing field for the industry
Pass a telecommunications law
Set up a multi-level pricing system that allows state-determined prices, state-directed prices and market prices.
Build a license policy that ensures competition.
Effectively manage bandwidth and frequencies.
Steps Telecommunications and Internet Sector Knowledge-Based Economy

The government‘s steps for regulation involve the central activities in an Internet economy. 07.06.09
Infra-structure
E-Commerce
Knowledge Based Economy
Content Control
Consumer Protection
Establishing Businesses
.....
International Gateway Channels
Interconnecting Networks
Internet Service Providers
Enduser Access
Investment Policy
Education
Research & Development
Innovation
.....

Since 1994, attempts have been made to create a stable institutional framework for the development of the infrastructure. 07.06.09 „ The Chinese Government does not want to clamp down on the development of the Internet sector. But we must find a more healthy way to manage it to ensure that individuals’ reputations and privacy are protected“. (Wu Jichuan, MII)
Government Regulation:
At the beginning of China‘s Internet age, two ministries fought to control the institutionalization of the Internet: the Ministry of Post and Telecommunication (MPT) and the Ministry of Electronic Industry (MEI)
1998: Consolidation of the MPT, MEI and other ministries as well as corporations to form the Ministry of Information Industry (MII) – concentrating on strengthening competencies in a single ministry.
Telecommunication Infrastructure Regulation:
Until 1994, China Telecom had a monopoly in the telecommunications industry.
1994/95 China Unicom and Jitong Communications (Golden Projects) established
1998 China Telecom is divided into various categories for paging, mobile communication, landline communication and satellites.
2002 China Telecom is divided geographically to form the China Telecom Group (21 southern and western provinces and municipalities) as well as the China Netcom Group (10 northern provinces and municipalities, plus the national backbone network of China Netcom and the national assets of Jitong Communications )
Clear top-down regulation with the goal of creating a competitive environment in order to allow for innovation, diffusion and restricted price wars.

To connect with international gateway channels, eight interconnecting networks are available in China 07.06.09 *non-commercial networks Source: in Anlehnung an Su, Qinsheng (2000): Zhongguo yintewang fazhan yu xiangguan zhengce [Politik der Internetentwicklung und –Zusammenhänge in China], http://www.cans2000.org.cn/others/ppt/other23.ppt (27.02.02), S. 19. Network Owner User Foundation CSTNet* Chinese Academy of Science (CAS) Research & development groups 4/1994 ChinaNet China Telecom Private and business users 5/1995 CERNet* Ministry of Education K-12 and higher education groups 11/1995 ChinaGBN Jitong Communications Corp. Private and business users 9/1996 UniNet China Unicom Private and business users 3/1999 CNCNet China Netcom Primarily business users 7/1999 CIETNet* Ministry of Foreign Economic & Trade Cooperation Groups and businesses involved in foreign trade 1/2000 CMNet China Mobile Mobile Internet users 1/2000

Institutional hierarchy levels in controlling Internet development 07.06.09 CNNET CNNET CNNET CNNET Ministry of Public Security Bureau of Public Security Bureau of Public Security Bureau of Public Security State Government Network Provider User Website Operator Competence conflicts Self-censure Monitoring required

Example of how political costs are created by content regulation: the seal and certificate from „HD315.gov.cn“ 07.06.09
Seal is provided by the „Beijing Municipal Administration of Industry and Commerce“ (BAIC)
Seal is needed by all e-commerce websites
„ HD“ stays for „Hong Dun“=„Red Shield“

An unstable institutional structure regulates content providers and e-commerce in China. 07.06.09
Characteristics of Institution Building for ICPs and e-commerce websites in China:
The legislature deals reactively to „initiatives“ from website operators and e-commerce businesses, and is rarely proactive.
As long as a special Internet regulation does not exist, then the existing laws (e.g. consumer protection, etc.) are used.
During the initial phase of Internet regulation, measures were „tested“ locally and then introduced nationally.
Milestones of Internet Legislature
MPT Order #675 (Sept. 1993): Computer services such as e-mail are open for non-MPT units.
“ Temporary Regulation of the Management of Computer Information Network International Connections” (Feb. 1996): Ensuring a “healthy development” of the Internet.
“ Administration of Commercial Encryption Regulations” - State Council Directive 273 (Oct. 1999): Regulation of encryption mechanisms
Public Pledge on Self-Discipline for the Internet Industry in China (March 2002): “Obligation to self-censure”
Controlling measures:
All ICPs must register with the Information Office of the State Council.
News portals that are not registered are only allowed to use content from registered portals.
Special permission is needed in order to link to foreign websites.
ISPs have to make tracking reports about content and user access available to the police and save them for at least 60 days
Overall, a relatively unspecific, instable framework that is open to considerable interpretation and hinders the development of the application layer!

Case Study: Agricultural „Expert Systems“ as a way of sinking transformation costs (I) 07.06.09 Source: Dr. Songde MA, Ministry of Science and Technology

Case Study: Agricultural „Expert Systems“ as a way of sinking transformation costs (II) 07.06.09

21. November 2003

Analyses of the digital divide examine the differences in the diffusion of the Internet based on various criteria. 07.06.09 National Digital Divide International Digital Divide
Shows differences between countries in
Telephone connections
Computer
Internet access
Internet users
Mobile technology users
Mostly technology based Digital Divide
Shows differences within a country in
Gender
Age
Race
Educational level
Income
Mostly sociological based Digital Divide
„ Digital Divide“ definition according to OECD: The term “digital divide” refers to the gap between individuals, households, businesses and geographic areas at different socio-economic levels with regard both to their opportunities to access information and communication technologies (ICTs) and to their use of the Internet for a wide variety of activities. Adapting the concept of the international digital divide to China It is possible to determine the technological digital divide between the provinces.

Der Digital Divide innerhalb Chinas kann anhand eines Indikator-Modells analysiert werden 07.06.09 Individual Indicators Digital Divide Indicator Pervasiveness Infrastructure Sophistication of Use The Pervasiveness takes the infrastructure already as given and analyses the factors which are on the side of the households, companies, government offices and educational institutions to have access to the Internet. The Connectivity Infrastructure analyses the infrastructural basis which is necessary to connect households, companies, government offices and educational institutions with the Internet. The Sophistication of Use analyses the actual level of use of the Internet with a given basis of hardware and infrastructure.
Phones
Computers
Internet users
Mobile Phones
Fiberoptical trunks
Number of ISPs
Telecommunications Investment
Registered Domains
Number of Websites

Beijing, Guangdong and Shanghai lead in the overall ranking of the digital divide index. 07.06.09 Cluster 1: Highly developed regions and cities Cluster 2: Regions and cities with above average development Cluster 3: Regions and cities that require considerable development Cluster 4: Barely developed regions and cities

There is a strong relationship between the Internet development and the GDP per capita as well as knowledge development 07.06.09 Cluster 1: Highly developed regions and cities Cluster 2: Regions and cities with above average development Cluster 3: Regions and cities that require considerable development Cluster 4: Barely developed regions and cities

The unequal distribution of Internet users in China overall decreased significantly between 1998 and 2002. 07.06.09 The Lorenz curve only enables a statement about the change and distribution in China as a whole – differentiation between the specific provinces is not possible here.

The digital divide can be more quickly overcome through mobile technology, but at the cost of media richness. 07.06.09 Richness Reach Low (e.g. text messaging services / e-mail) High (e.g. WWW) Low High Trade-off WWW Trade-off Mobile Technology Mobile Technology WWW

Currently, the costs for building institutions seem to be greater than the benefits that could possibly result from it. 07.06.09 Infrastructure High Costs Completely new structuring of the institutional framework High Benefits By creating competition, the Internet is quickly diffused with simultaneously sinking prices E-Commerce Medium Costs A few guidelines more likely to lead to confusion than to security – up till now, there is no Internet/ e-commerce law! Medium Benefits Internet businesses rush to be obedient, but free development is hindered. Knowledge Transfer Low Costs Up to now, only a few measures introduced – some projects are still in the pilot phase. Low Benefits Distribution of the Internet too small – many initiatives are not implemented beyond the pilot phase. Short term perspective: The eastern provinces profit much faster and to a greater degree from Internet development than the inner provinces.  The digital divide decreases without having an influence on decreasing the economical divide. Long term perspective: The inner provinces can profit from using e-commerce, knowledge transfer and the sinking transformation and transaction costs that are related to them.  The digital divide decreases simultaneously with a decreasing of the economical divide.  Due to the low volume up to now, it is not possible to quantifying the effects.

The economical differences cannot be overcome by the Internet, at least not in the short term. 07.06.09 It‘s essential that the Internet expand into the western provinces and that schooling and education is offered so that these provinces can catch up with the coastal regions! Western Provinces Eastern Provinces Converging Effect Diverging Effect Development Gap Monetary Transfer Potential economical influence through use of Internet

07.06.09 Thank You!

Kontakt: 07.06.09 Dr. Christian Schmidkonz Partner @ THINK!DESK China Research & Consulting Internet: www.thinkdesk.de E-Mail: [email_address] Skype: thinkdesk Twitter: www.twitter.com/thinkdesk Slideshare: www.slideshare.net/thinkdesk XING: http://www.xing.com/net/china/ DISCLAIMER: The information contained in this presentation is based upon or derived from sources that are believed to be reliable; however, no representation is made that such information is accurate or complete in all material respects, and reliance upon such information as the basis for taking any actions is neither authorized nor warranted. This presentation is intended for the use and assistance of clients of THINK!DESK China Research & Consulting. It should not be regarded as a substitute for the exercise by the recipient of their own judgement. THINK!DESK China Research & Consulting and/or any person connected with it accepts no liability whatsoever for any direct or consequential loss of any kind arising out of the use of this presentation or any part of its contents. It should be noted that a variety of factors, including e.g. changes in prices, shifts in demand, variations in supply, international currency movements, technological developments, governmental actions and/or other factors, including our own misjudgements or mistakes, may cause the statements herein concerning present and future conditions, results and trends to be inaccurate.

Internet in China - Transaction Cost Reduction with Increasing Political Costs

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Internet in China - Transaction Cost Reduction with Increasing Political Costs Presentation Transcript