Technological and economic decoupling is materializing in some parts of the digital economy, with risks of large global welfare losses. While this is often motivated from a security perspective, there are also fundamental economic reasons for a country to erect trade barriers and in effect promote decoupling. One result, also found in the trade literature, is that banning imports may be optimal in monopolistic sectors, such as the digital sector. But more novel is that banning exports can also be optimal from the perspective of a technological leader, as it prevents technological diffusion to a challenger that may eventually become the global supplier, capturing monopoly rents and posing cybersecurity risks. We propose avenues for international cooperation to deliver better outcomes.

Since World War II, no economy has come close to challenging the overall technological and economic dominance of the United States—until China. The former Soviet Union challenged the United States mainly on military and space technology. Other economies competed only in select sectors or were U.S. allies. China, however, is the first to compete on a similar scale and across a broad swath of new technologies, while not being part of the U.S. security blanket. This has raised new issues for the globally integrated trading and monetary system.

As the United States and China compete for leadership of the technologies of the future, new trade restrictions have arisen in digital sectors not only between them but also involving other nations. This includes import and export bans of next generation (5G) network technologies, semiconductors, access to social media platforms, data-based security applications, and the like. These restrictions haveraised fears about technology wars becoming the new trade wars, leading to a decoupling or splintering of global supply chains with adverse consequences for many.

There are two distinct, but related, dimensions of this competition. First, in a digital era with strong economies of scale and scope, leadership in emerging technologies can bestow outsize profits, global market shares, and the ability to set standards. New services built on data, such as artificial intelligence, 5G networks, the internet of things, and quantum computing have opened the way for new growth engines that promise to transform entire industries and lift productivity. This trend toward an increasingly digitalized and networked world has only accelerated with the COVID-19 pandemic. With the promise of monopolistic rents, global economic leadership of new technologies is highly prized.

Second, the digital era gives rise to new security concerns, as digital technologies do not conform to traditional borders and protections. The networked economy makes it possible to reach seamlessly across the world to collect information, learn from others, and make decisions, enhancing economic efficiency. However, it also allows thieves, saboteurs, and spies to steal, copy, manipulate, or destroy, including stealthily across borders. Digitalization and connectivity have sped up the international diffusion of knowledge while simultaneously spawning new security threats—as exemplified by a number of high-profile incidents such as the shutdown of the Colonial Pipeline, the SolarWinds breach, or the NotPetya malware.

The interconnections of the digital era blur traditional distinctions between economic and security issues. Simultaneously engines of economic growth and channels of security risks, the interconnectivity can incentivize the use of economic policy tools, such as trade and industrial policies, not only for traditional economic gains but also for broader security or geopolitical gains.

A Trade Paradigm Shift

In two recent pieces (found here and here), we argued that if one considers the key features of the digital sector—large market power driven by scale economies, international technology flows, and security risks—it becomes easier to understand some of the recent policy actions outlined above. This also implies that some of the conventional conclusions drawn in the trade economics literature may no longer apply. In particular, export and import bans on new technologies can be rationalized from the perspective of an individual economy, although they impose large negative spillovers onto the rest of the world.

In our analysis, a key motivation for banning technology imports—provided a country hosts a potentially viable substitute—is to repatriate monopoly profits that would otherwise accrue to foreign firms. Banning imports is also more attractive given the potential of cybersecurity vulnerability to foreign actors, which we model as a differential cost in using a foreign digital technology. However, this could halt inflows of technological knowledge and, hence, may be desirable only for a country at a sufficiently advanced technological level. While trade economists have long pointed out that banning imports may be beneficial in sectors involving monopoly rents, the increase in market power observed across the digital economy accentuates the motive to do so.

Our novel finding, however, is that banning exports can also be beneficial for an individual country in the digital economy. A technological challenger can successfully displace a leader as the global producer and capture monopoly rents because of international technology diffusion and domestic scale economies. To forestall such an outcome and reduce the associated cybersecurity vulnerabilities, the leader of a certain technology may seek to ban its exports.

Two key assumptions underpin this finding. The first is that increasing returns to scale in the new digital technologies are global in nature. Global increasing returns are what incentivize the quest to dominate global markets. If the returns to scale were limited, so too would be the economic gains. This would diminish the motives to put up import or export barriers.

The second relates to the intrinsic technological growth rates (i.e., excluding international technology spillovers) of the leader and the challenger. If the leader’s technological growth rate outpaces that of the challenger, there is no incentive for the leader to impose a trade ban; the leader will outcompete the challenger. If, on the other hand, the growth rate of new technologies of the challenger is similar to or higher than that of the leader, the leader will have an incentive to impose trade bans to limit catch-up and reduce market access or the scale economies available to the challenger. In the case of similar technological growth rates, an import ban would suffice as it would keep the challenger from achieving the scale needed to overtake the leader. But if the challenger’s technological growth rate is expected to be higher, then the leader may resort to more deleterious export bans to limit technological diffusion and catch up.

Export bans are also different from import bans in that they cannot be deterred via retaliatory trade policies. Retaliatory trade policies or the anticipation of reciprocity have, until recently, been believed to act as a deterrent to trade bans. The logic has been that an import ban might help a producer gain an advantage in global markets, but reciprocation by a competitor would lead to worse outcomes for both. However, in the digital economy, export bans cannot be effectively deterred. Once the challenger is cut off from access to a superior technology, it has few tools left to retaliate within the realm of trade or industrial policy in that particular sector, although conflict could potentially spill over to other areas.

Trade bans could benefit producers or prospective producers of new technologies. But they prevent other countries from accessing digital technologies and can lead to inefficient decoupling from global supply chains. Costs are amplified when allies follow suit. Thus, it is imperative that cooperative frameworks are set up or improved to internalize the costs and promote better outcomes.

The Need for Cooperation

The rest of the world suffers unambiguously from technological trade wars. Countries caught in the middle of the competition between the United States and China should spearhead cooperative solutions and work actively with both technological competitors to promote trust. Such solutions should seek common ground in areas of mutual interest such as securing property rights, combating cybercrime, maintaining financial stability, and taxing and regulating large digital companies.

The first area of cooperation is securing intellectual property rights across borders. Minimum enforced standards are in everyone’s interest and would reduce concerns about misuse, forced transfers, or theft. They would thus diminish the incentives for a technological leader to impose export bans.

Clear, transparent, and uniform rules will also be needed on the interaction between the public and private sectors. Governments’ partnerships with domestic cyber technology firms for purportedly national security purposes, including surveillance, should be clearly delimited.

A related area is cybersecurity. The advent of the internet has facilitated an explosion in cross-border online crime. In cyberspace, there are no effective domestic norms or public institutions for enforcing security, such as “e-police” or an “e-justice system,” and no international mechanisms for de-escalation and maintaining peace. These need to be developed both domestically and internationally.

A digital stability board—in the image of the Financial Stability Board—to develop common standards, regulations, and policies, share best practices, and monitor risks could help enable broader progress and openness in trade of digital services, protect people and businesses from cyberattacks, and safeguard financial stability.

Facilitating ownership and control of monopolistic digital goods firms by private foreign shareholders would broaden the sharing of rents across countries, align incentives for better global outcomes, and discourage trade conflict. Open financial or capital accounts to permit such ownership, governance arrangements to facilitate control, upholding foreign property rights, and narrowly circumscribing areas subject to national security arguments are prerequisites.

Regarding regulatory policy, if consideration is given to breaking up large domestic technology firms to reduce their monopoly profits or otherwise regulating prices, this ideally should be done in concert across nations. The absence of a concerted effort could reduce the incentives for any country to pursue sustained action; if only one country or region moves toward strong regulation while foreign monopolists are free to compete, that country or region could lose its economies of scale and scope, and risk falling behind in the race for technology and markets.

Coordinated initiatives to introduce digital taxation would similarly be more effective and perceived to be fairer. Tech giants benefit from selling goods and services online across borders with limited physical presence and facing little income tax liability in the buyer’s jurisdiction under existing international tax arrangements. This favors tax arbitrage and creates an uneven playing field.

The Need for Coalitions of Reformers

To summarize, large economies of scale and scope in the production of digital goods, combined with new concerns about security, offer powerful incentives to producers and potential producers to use trade policies to safeguard their markets. Yet trade bans come at large costs to others. To internalize these costs and promote better outcomes, it is critically important for multilateral coalitions of like-minded reformers to step forward and undertake sustained and concrete action to address the new challenges of the digital age.

Daniel Garcia-Macia is an economist in the IMF’s European Department. He previously served in the Research Department, and his research has been published in Econometrica among other journals. He holds a Ph.D. in Economics from Stanford University

Rishi Goyal is assistant director in the IMF’s Western Hemisphere Department. He has been the IMF’s mission chief to Greece, Italy, and Mexico, and acting chief of the IMF’s strategy unit, among other positions. He holds a Ph.D. in Economics from Stanford University.

The views expressed herein are ours alone and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. This article is based on two recent papers, Garcia-Macia and Goyal (2020 and 2021). We thank Daniel Guelen for his invitation to publish and editing, and Adam Behsudi and Bridget Gah-Che Chan for their suggestions.