42 WORLD DEVELOPMENT REPORT 2016

enabling digital development

How the internet

promotes development

To understand how the internet and related digital central importance of connectivity. Faster computers
Spotlight 1

technologies affect development, it is important to and cheaper storage are useful in their own right. But
understand what they actually do. It turns out that the reason that all of these technologies have had such
old economics explains the new economy quite well. a massive impact on almost all aspects of life is that
In 1937, Ronald Coase—who would receive the Nobel these devices are linked so that information can be
Prize in Economics in 1991—published “The Nature of distributed and accessed effortlessly from anywhere.
the Firm,” which asked why firms exist.1 Even though
economics considers the market the most efficient
way to organize economic activity, large companies
The internet promotes
tend to operate in a self-contained command-and- inclusion, efficiency, and
control environment. What Coase realized was that innovation
using the price mechanism incurred a number of
additional costs, such as the effort of finding buyers Technology development has vastly reduced the cost
or suppliers, and negotiating contracts and enforcing and increased the speed of all the digital technologies
them. As long as the cost of making an exchange of an that drive the internet—in some cases by more than
intermediate good or service in the market is larger 30 percent per year. This continues a long-term and
than the profit from that exchange, it is rational for a accelerating decline in the cost of computing. William
firm to produce it in-house. Nordhaus, in 2007, estimated that since the era of
Most of these Coasian transaction costs stem from manual computing in the mid-19th century, the cost
the costs of acquiring and sharing information. Many of a computation has dropped by a factor of between
years later, the internet and other digital technologies 1.7 trillion and 73 trillion.2 The result has been a far
have vastly reduced many of these costs, with major lower cost of acquiring and using information, which
implications for market and nonmarket exchanges in turn has lowered transaction costs—and often as a
among businesses, people, and governments. This consequence, production costs.
spotlight describes how the decline of these transac- By lowering the cost of these transactions, the
tion costs affects economic development. But first, a internet affects economic development in three
working definition of the technologies covered in this major, interrelated ways. One is that the internet
Report. can help overcome information problems. In some
While the World Development Report 2016 is not instances, a mutually beneficial transaction might
about specific technologies, it generally covers the not take place because the two parties simply had no
impacts of digital technologies and services that way to find each other or acquire enough information
greatly facilitate the creation, storage, analysis, and to confidently proceed with the transaction; in such
sharing of data and information. The Report uses the cases, the transaction costs are essentially infinitely
terms “digital technologies,” “internet,” and sometimes high. The emergence of e-commerce platforms has
“information and communication technologies (ICTs)” made it much easier for small producers to find
somewhat interchangeably. “Internet” emphasizes the customers, and even for individuals who cannot use
 HOW THE INTERNET PROMOTES DEVELOPMENT 43

traditional marketing tools like advertising or trade add up to enormous aggregate benefits. Better com-
shows. Rural artisans in Morocco, some of whom munication and information processing improves
are illiterate, have set up Anou, a web shop for their supply chain management and enterprise resource
products that has attracted customers from all over planning. Retailers now share point-of-sale data with
the world.3 The internet, by vastly lowering search vendors globally in real time, essentially shifting
and information costs, creates these markets. This inventory management to their suppliers. Tracking,
has many benefits, but the most important, arguably, navigation, and scheduling software improve capac-
is that it fosters inclusion—in new and existing mar- ity utilization for logistics and transport companies.
kets, in social interaction, or in government service The delivery company UPS famously saves about
delivery systems. Inclusion for the individual usually 1 million gallons of gas each year by using routing
means expansion of a market by those on the other technology that minimizes left turns, where vehi-
side of the transaction, such as a firm or a govern- cles are often held up by oncoming traffic. Estonia’s
ment that now serves more citizens. X-Road is an e-government system that offers nearly
Even when search costs are low, transactions often 3,000 services from 900 government and private
do not take place when one party to a transaction sector agencies to the citizens online. The number of
has much more information than the other. Take the queries made through X-Road increased from half a
example of extending credit to poor farmers. The high million in 2003 to 340 million by 2014. As a result, each
cost of gathering information about poor borrowers citizen saves about five working days per year, adding
is a major deterrent to lending by banks.4 The poor up to 7 million workdays overall.

Spotlight 1
therefore need to rely on informal moneylenders who For many internet-based businesses or services,
charge exorbitant interest rates. But many of the poor fixed up-front costs can be high, but once the online
possess mobile phones. Companies such as Cignifi platform is in place, each additional customer, user, or
have developed methods to judge the creditworthi- transaction incurs very little extra cost. The marginal
ness of a potential borrower based on their mobile transaction cost essentially drops to zero because
phone records. In Ghana, Cignifi worked with the what previously involved routine human labor can
World Savings and Retail Banking Institute to cor- now be fully automated. This has led to enormous
relate savings behavior with mobile phone records.5 innovation—the third mechanism—that is typically
The goal is to promote financial inclusion among associated with the “new economy.” These dynamics
the unbanked, by assessing the savings potential have important implications related to the nature
and creditworthiness of low-income households that of the scale economies that make this innovation
own mobile phones but have no access to financial possible, the new business models (and competition
products. problems) this has spawned, and the unprecedented
There is a large literature on information problems scope for customization of services.
and asymmetries by economists such as George Aker- The cost structure of many internet businesses
lof, Michael Spence, and Joseph Stiglitz, who jointly gives rise to various types of scale economies.7
received the Nobel Prize in 2001. Akerlof was moti- Supply-side scale economies, where costs drop with
vated to write his most famous paper, “The Market an increasing number of transactions, favor the
for Lemons,” published in 1970, by the fact that when emergence of natural monopolies. Water or electric
buying a used car, the seller usually has much more utilities operate in similar environments. Because
information about the car’s quality than the buyer.6 entry costs are also high, such sectors tend to be
Today, internet sites such as Carfax in the United regulated. Many internet-based markets—such as
States let buyers research the history of a car online, web searches, mobile payments, or online book-
including whether it has been in an accident, how stores—are also dominated by a few firms. At least
many owners it has had, and whether it has complete initially, entry costs are low and such websites can
service records. scale up extremely quickly, even with relatively
The second mechanism is closest to the original few resources. Facebook reached half a billion users
Coasian concepts of transaction and coordination with just 500 engineers.8 Walmart had to build 276
costs. Most transactions were already taking place stores before reaching US$1 billion in sales; Amazon
before the digital revolution, but the internet has made needed just six warehouses to reach US$3 billion in
them faster, cheaper, or more convenient. In other 2003.9 For many of these firms, the product they sell
words, lower transaction costs raise the productivity is also purely digital, such as digital music (Spotify in
of existing factors of production. The internet has Sweden), e-books (Amazon in the United States), or
brought numerous efficiency improvements to busi- online news and data.10 Others sell highly automated
nesses that, while individually often not spectacular, brokerage or matchmaking services for travel, jobs,
44 WORLD DEVELOPMENT REPORT 2016

merchandise, or ride sharing. Many of these business Figure S1.1 Internet users trade
models have been replicated by firms in developing personal data for useful services
countries. But even there, in many of these markets, a
high degree of concentration has occurred in the last Platforms
10 years. While in the early 2000s internet traffic was Google, Facebook, and so on
distributed across thousands of companies, today just

d)
30 companies account for over half of peak internet

Us
lou

er
,c
traffic in the United States—much of this is due to the

an tisi
Ad
ail

es)

d c ng
-m

ver
explosion of video content.11

nc

ust sp
,e

ere
Scale economies also exist on the demand side. For

om ace
rch

ref

Mo

er
ea

lp

ne
many services, the more people use it, the more valu-

s (s

pro
na

y
rso
able it becomes to its users and the more new users it

ice

file
erv

(pe
attracts. Social media sites or digital payment systems

es

ta
Da
Fre
like M-Pesa in Kenya are examples. With supply-side
scale economies, average cost drops with scale. With
Goods and services
demand-side scale economies, average revenue or
Users Vendors
utility rises with scale. These network externalities
Money
benefit users, but can also create lock-in effects; to
switch to a different social media platform imposes Source: Based on Kurbalija 2015.
Spotlight 1

very little actual cost on the user, but would require

collective action by a large number of interconnected
users to maintain the same level of utility.12 mediated transactions.14 The main benefit to the user
Ultralow marginal transaction costs have powered is that services can be tailored to individual needs and
new business models. Many of these are web services preferences—although at the cost of giving up privacy.
operating platform markets or two-sided markets. For the seller, it allows more targeted advertising and
The platform owner has two different customers, even price discrimination, when automated systems
typically the user of the service and an advertiser can analyze user behavior to determine willingness to
who wants to reach the user. Rather than charging pay and offer different prices to different users.
both, it makes sense to provide the service for free There is ample evidence that e-commerce sites
and increase the user base (at very little cost), which vary prices based on users’ estimated location, brows-
makes the other side of the market more lucrative. A ing history, and even the type of device they use for
classic 2003 paper by Jean-Charles Rochet and Jean access.15 Information can flow both ways, since many
Tirole shows that two-sided markets exist in many commercial websites provide feedback mechanisms
industries. 13 But the economics of the internet have that help the provider improve the product, but also
led to a particularly effective grand bargain between allow the customer to assess the quality of a product
platform owners, users, and advertisers (figure S1.1). or service. Businesses use such tools extensively,
This model raises difficult questions about competi- but the public sector has been slow to adapt them for
tion policy. Because platforms often do not charge for better service delivery.
a service, they do not actually exert monopoly power Finally, in many, if not most, transactions, more
over users. But they could do so over vendors buying than one of the three mechanisms may be at work.
advertising space. Just four companies—Google, For example, transactions on internet platforms typ-
Facebook, Baidu, and Alibaba—now account for half ically involve all three. While the platform running a
of all digital advertising revenue. And, dominant plat- fully automated service is the main innovation, one
forms could exert monopsony power (because there side of the transaction often involves a provider of a
is a single or are just a few buyers). For instance, book service, such as an informal driver working through
publishers depend on Amazon for a crucial share of a ride sharing platform or a freelance worker in a
their total sales. remote location. For them, it will often be a case of
Because most processes can be automated, there inclusion in an otherwise inaccessible market trans-
is tremendous scope for customization of services. action. The customer at the other end of the transac-
Most online behavior is automatically monitored— tion experiences increased efficiency. A service that
sometimes anonymously, sometimes not. The mas- was typically available through another channel is
sive data volumes collected by internet platforms now more convenient, faster, or cheaper. Figure S1.1.1
have created a whole new branch of economics— in box S1.1 presents a graphic representation of the
nano-economics—which studies individual, computer- three mechanisms.
 HOW THE INTERNET PROMOTES DEVELOPMENT 45

Box S1.1 Three ways in which the internet promotes development

Figure S1.1.1 provides a simple graphic representation of Figure SB1.1.1 A graphic

the effect of falling transaction costs. Imagine all transac- representation of how the internet
tions in an economy arranged by the transaction costs they promotes development
impose, from most costly on the left to least costly on the
right. The upper curve shows these costs before the intro-
duction of the internet. With the internet, many such costs
drop, and three things can happen. On the left, there were Pre-internet
some transactions for which the cost was so high in the Post-
internet
pre-internet era, that there was essentially no market—the

Transaction costs
transactions did not take place. Making these transactions
possible promotes inclusion as well as market expansion.
For example, women with small children or persons
with disabilities have sometimes been unable to engage
in work outside the home, but can now engage in tele-
work.a Many poor or disadvantaged populations will now
receive public services because governments can use

Spotlight 1
digital IDs to verify their eligibility.b And skilled workers
and small firms in poor countries can trade their services
Inclusion Efficiency Innovation
in global markets, where they can earn higher returns.
These are all examples where the internet, by overcoming Transactions, arranged from high to low cost
information problems, contributes to greater inclusion. Source: WDR 2016 team.
In the middle of the figure, the internet lowers the
cost of existing transactions—that is, those occurring The most dramatic impact of the internet is on the
even before the advent of the internet. This raises the right-hand side of the figure. For many internet-based
efficiency of a vast range of activities. Purchasing goods, businesses or services, fixed up-front costs can be high,
executing bank transactions, searching for a home or but once the online platform is in place, each additional
a job, paying taxes, or renewing a driver’s license gen- customer, user, or transaction incurs very little extra cost.
erally used to require a trip to a shop or office, but can In many cases, the marginal transaction cost is essentially
now be done with a click or a tap. Similarly, the internet zero because what previously involved routine human
has reduced costs for businesses when connecting and labor can now be fully automated. For purely digital
negotiating with buyers or suppliers, finding workers products, such as e-books, the marginal production
through job-matching services, and monitoring contract cost is also close to zero. This cost structure gives rise
fulfillment or employee performance. Many of the same to various types of scale economies, often reinforced
benefits extend to governments, as well. These individu- by network effects, where the more users a system has,
ally unspectacular efficiency gains may, in the aggregate, the more useful it becomes.c Most of the so-called “new
represent the lion’s share of benefits from the internet. economy” firms are in this space.

Source: WDR 2016 team.

a. Melhem, Morrell, and Tandon 2009.
b. Gelb and Clark 2013.
c. Varian and Farrell 2004.

Notes
1. Coase 1937. 8. Levin 2011.
2. Nordhaus 2007. 9. Ellison and Ellison 2005.
3. [Link] 10. Shapiro and Varian 1999.
4. Banerjee and Duflo 2011. 11. Congressional testimony of Craig Labowitz, chief
5. Cignifi and WSBI 2014. scientist of the software company, Arbor, quoted
6. Akerlof 1970. in [Link]
7. Shapiro and Varian 1999; Varian and Farrell 2004. _missing/.
46 WORLD DEVELOPMENT REPORT 2016

12. Switching costs are far higher when replacing a Kurbalija, Jovan. 2015. An Introduction to Internet Gover-
widely used software package, since it will require a nance. 6th ed. DiploFoundation.
lot of retraining and associated investments, such as Levin, Jonathan D. 2011. “The Economics of Internet Mar-
enterprise resource planning or operating systems. kets.” NBER Working Paper 16852, National Bureau
13. Rochet and Tirole 2003. of Economic Research, Cambridge, MA.
14. Varian 2014; Varian and Farrell 2004. Melhem, Samia, Claudia Morrell, and Nidhi Tandon.
15. Pasquale 2015. 2009. “Information and Communication Technolo-
gies for Women’s Socioeconomic Empowerment.”
Working Paper 176, World Bank, Washington, DC.
References Nordhaus, William D. 2007. “Two Centuries of Produc-
Akerlof, George A. 1970. “The Market for ‘Lemons’: Qual- tivity Growth in Computing.” Journal of Economic His-
ity Uncertainty and the Market Mechanism.” Quar- tory 67 (01): 128–59.
terly Journal of Economics 84 (3): 488–500. Pasquale, Frank. 2015. The Black Box Society. Cambridge,
Banerjee, Abhijit, and Esther Duflo. 2011. Poor Economics: MA: Harvard University Press.
A Radical Rethinking of the Way to Fight Global Poverty. Rochet, Jean-Charles, and Jean Tirole. 2003. “Platform
New York: PublicAffairs. Competition in Two-Sided Markets.” Journal of the
Cignifi and WSBI (World Savings and Retail Banking European Economic Association 1 (4): 990–1029.
Institute). 2014. Mobile Phone Data as the Key to Promot- Shapiro, Carl, and Hal R. Varian. 1999. Information Rules: A
ing Financial Inclusion. Cambridge, MA: Cignifi and Strategic Guide to the Network Economy. Cambridge, MA:
WSBI. Harvard Business School Press.
Coase, Ronald H. 1937. “The Nature of the Firm.” Econom- Varian, Hal. 2014. “Big Data: New Tricks for Economet-
rics.” Journal of Economic Perspectives 28 (2): 3–28.
Spotlight 1

ica 4 (16): 386–405.

Ellison, Glenn, and Sara Fisher Ellison. 2005. “Lessons Varian, Hal, and Joseph Farrell. 2004. The Economics of
about Markets from the Internet.” Journal of Economic Information Technology: An Introduction. Cambridge,
Perspectives 19 (2): 139–58. MA: Cambridge University Press.
Gelb, Alan, and Julia Clark. 2013. “Identification for Devel-
opment: The Biometrics Revolution.” Working Paper
315, Center for Global Development, Washington, DC.
HOW THE INTERNET PROMOTES DEVELOPMENT 47