Originally shared on The World Economic Forum.
Amid the waves of populism currently engulfing many Western democracies, it’s all too easy to forget the core purpose of governments; what the men and women who roam the corridors of power, and the civil service who support them, are actually supposed to do.
In my view, governments have four overriding (and somewhat overlapping) duties.
The first is to regulate: to pass laws, preserve and protect democracy, limit corruption, and strike the right balance between ensuring stability and allowing citizens to run their own lives. When (widely) unforeseen events, such as the 2008 financial crisis, take place, their task is to steer the oil tanker of government through the ensuing storm and reduce the impact on households and businesses. Failure to do so invariably brings administrations down – a sign that democracy, for all its flaws, is functioning and, if the need arises, the electorate can still kick incumbents in the teeth.
A democratic government’s second role might loosely be termed “redistribution”: to uphold a social contract with its citizens, whereby the poorest and most vulnerable are protected. This strand of governance encompasses everything from resourcing and maintaining a viable health service to providing support for the unemployed.
The third is investment in critical infrastructure (roads, bridges, airports) and education (from nurseries to universities), as well as those areas that cannot be left to the mercy of the markets alone – scientific research, the arts, sports, historical monuments and national parks, for example.
The fourth, and some might argue the most important responsibility of government, is to protect its citizens and uphold the rule of law. Without police, a functioning court and legal system, a military and agencies to safeguard people against everything from global pandemics to natural disasters and from homegrown terrorism to external aggression, society in any meaningful sense cannot exist. That Western societies do not descend into riots and mass lawlessness is testament to the fact that representative democracy by and large works.
Of course the degree to which democracies prioritize these four areas varies profoundly. The United States under Donald Trump, for example, is set to spend heavily on infrastructure and defense, while slashing the government workforce (indeed, at the time of writing, he had already ordered a federal hiring freeze). Meanwhile, nations such as France, Finland, Belgium and Denmark devote far more than the OECD average to social services.
Yet, however they spend their budgets, broadly speaking, Western societies, led by the US, were built on the same premise. Namely that governments and major corporations must work together to build long-term stability. Across the past century, as the Stratechery’s Ben Thompson describes, this unwritten contract meant that – via trade treaties, military and police protection, investments in infrastructure and research – governments ensured the development and acquisition of markets for businesses. In return, the private sector provided stable full-time jobs, financing health insurance and pensions for their employees.
At least that was the way it used to work.
Digital changes everything
For all its upsides, the digital revolution – which has done so much to transform our daily lives – has not so much disrupted this decades-old model as upended it. The implicit understanding and partnership between governments and businesses has become unworkable, threatening the very fabric of democracy.
To understand why, it’s first necessary to consider the particular characteristics of lean digital businesses that set them apart from the traditional corporate world, which is itself scrambling to adjust. There are five of them; together, they are game-changing.
First is what we might term “non-localization”. Whether it’s the companies themselves, their headquarters for tax purposes or the teams who build and run them, locations no longer matter and borders are irrelevant. Digital businesses, like talent and money, are fluid and can now base themselves anywhere. Not so long ago, if you wanted to market your product or service in India, you needed a distribution network, an office and employees there. Today, you can build a thriving SaaS product in India, from London, Amsterdam or Palo Alto. Or as a startup in Paris or Stockholm, you can outsource your entire back-office or sales team to India, without even getting on a plane.
Next, many internet businesses are simply platforms or marketplaces (think eBay, Uber, Airbnb, and Etsy), which connect demand and supply, or buyers and sellers. While the battle still rages as to whether Uber is an employer or merely a facilitator for self-employed “entrepreneur” drivers, there’s little doubt on which side the firm itself comes down. Similarly, even those celebrated billion-dollar tech unicorns that do employ staff require far fewer than “traditional” tech corporations. Founded over a century ago, IBM, for example, had over 377,000 employees in 2015; Google, less than two decades old, has a rather more modest workforce of fewer than 16,000. Meanwhile, WhatsApp had around 35 employees when it was acquired by Facebook for $19 billion in 2014. What a fully-automated digital business 20 years from now might look like, we can only imagine.
The network effect digital businesses enjoy creates a winner-takes-all environment, while the consequent and ever-expanding data deluge enables such companies to drive efficiencies and do far more with less. The net result of fewer successful companies employing ever-fewer people is of course a hugely reduced tax base – with the burden of healthcare and pensions falling on individuals, and ultimately, increasingly, government. Furthermore, the fact that these companies are not tied to any particular geography and can base themselves wherever is most tax-efficient (in fact, governments are scrambling to offer incentives to attract these corporations) explains why corporate taxation rates across 28 G20 and OECD countries have plunged from an average of 45% in 1983 towards 25% today.
As a result, the aforementioned contract between corporations and government is slowly splintering; few would doubt who holds the whip hand today.
The list of obligations it is increasingly difficult for governments to fulfill looks set to grow. The squeeze on corporate tax revenues and the coming impact of AI/automation on jobs makes it harder for government to tax and regulate businesses and, as a consequence, hamstrings its role as redistributor. Meanwhile, rising numbers of participants in the gig economy – and according to the McKinsey Global Institute, 20-30% of the labour force in the US & EU-15 are now classified as independent workers – make protecting workers’ rights evermore fraught and complex.
Nor can governments continue to effectively protect their citizens’ privacy. The explosion in the number of data-brokers (there are at least 4,000 data broker companies worldwide and the industry is estimated to be worth some $200 billion), who gather, repackage and resell data derived from publicly available records and online activity, means that private corporations are increasingly straying onto what was traditionally government turf. Areas such as security, censuses and healthcare are just another market opportunity for digital companies who, by definition, prioritize profit over the public good.
And the fact that many hundreds of millions of people have freely handed over their private data to the likes of Facebook, Twitter, Google, Amazon, Apple and countless others – who have a great deal of freedom to use this data as they see fit – merely emphasizes how governments, who are hardwired to regulate existing behaviours rather than future ones, are reduced to playing catch up with businesses who can – and do – outmaneuver them at every turn.
Slipping into irrelevance
All of the above factors are steadily converging to create a perfect storm for the very notion of Western liberal democracy. As the power of tech companies continues to grow, the corresponding legitimacy of governments starts to leach away. After all, how can a government enjoy the trust of its people if it can no longer fulfill its fundamental obligations? Put even more starkly, if it cannot serve its citizens, or adjust to the hyper speed of the digital economy, then government itself is in danger of slipping into irrelevance.
Indeed, if things do not change, then I believe two extreme yet entirely plausible scenarios may soon see the light of day. In the first – and arguably we are already starting to see this – governments, hemorrhaging power, will start to assert their authority in a very aggressive way. With their backs to the wall, they will become increasingly authoritarian, pandering to tides of popular anger by blocking immigration, stigmatizing minorities, vilifying opponents (and I include the free press here), nationalizing businesses, and beefing up security laws, including, in all likelihood, forcing tech companies to create backdoors with which to collect information on all citizens “in the public interest”.
In the other scenario, governments will become mere gatekeepers, as they grow increasingly algorithmic, with policy shaped by data and public services outsourced to private businesses and the slipstream of the marketplace. Under such circumstances, it is all but certain that regulatory oversight of corporations will be dramatically scaled back, in effect ripping up a government’s contract with its people.
4 main areas to be addressed
Yet, while we may be edging closer to such doomsday scenarios, there is still time for reform. Going into any depth on the necessary steps would require several thousand more words. So, at a high level, I’d argue there are four main areas which urgently need to be addressed.
As money equals power, the first is “solving” corporate taxation. This is an issue which politicians are fond of talking about, but rather less inclined to confront. Why? Because they run headlong into difficulties with the very employers they rely upon to create and maintain jobs for their populations.
In an era where corporation tax rates are in free-fall, certain tech giants have deeper coffers than many exchequers and digital multinationals have become ever more adept at tax avoidance (as opposed to evasion), governments of all stripes need to work together to forge a global response and secure this income stream for the long term. This is likely to involve moving to a destination-based cash flow taxation model, where the location of sales supersedes that of operations. Some tentative steps have been taken in this direction, but meaningful implantation is still a pipedream.
Next, labour laws need an urgent reboot so that they take into account that the on-demand economy is no passing fad, but a sea change in the way people transact. Anyone who doubts the staying-power of the gig economy should consider the way urban lives have changed over the past few years. Millions have grown used to summoning a car, a restaurant-cooked meal or a flat-pack furniture assembler to their door with a couple of taps of their phone. Regulating this growing industry out of existence may be popular with a few incumbents (such as taxi drivers and hotel chains), but would be a major blow to innovation and unlikely be supported by the population at large. That’s why governments should work together to rebuild social protections with on-demand platforms, rather than despite them.
Borrowing heavily from an analysis by the Information Technology and Innovation Foundation (ITIF), I’d suggest a couple of options for better supporting on-demand workers. One is to create a new category of worker, which would fall somewhere between full employee and freelancer, with associated protections. Another is to revisit each labour law, in turn, to adapt them to the new reality, focusing on the law’s original intention rather than fixating on whether a worker is an employee or not (we need to get over that distinction, and fast). In the meantime, as the ITIF suggests, lawmakers could introduce temporary exemptions for the gig economy, while these laws are debated and revamped.