Who should finance digital ecosystems?

Mar 22, 2022 07:25 PM IST

The complexities of the ecosystems call for a private-public balance, which ensures that citizens are empowered by technology, and also protected from its harmful side-effects

In evaluating the most appropriate financing options for digital ecosystems, policymakers must identify the objectives they are looking to achieve and select the funding option most appropriately aligned with those objectives.

Had it not been for the government’s initial investment in the development and proliferation of BHIM, UPI may never have achieved the success it enjoys now. The market failure here was a missing market. (Shutterstock) PREMIUM
Had it not been for the government’s initial investment in the development and proliferation of BHIM, UPI may never have achieved the success it enjoys now. The market failure here was a missing market. (Shutterstock)

In certain circumstances, public financing is unavoidable. For instance, where the information system in question provides essential government services such as tax (Goods and Services Tax Number or Tax Identification Number), there is no option but to ensure that these digital ecosystems are financed using public funds. Similarly, in the context of government databases with access to sensitive information, safety considerations might prohibit private sector participation.

That said, with the exception of digital systems that relate to essential State functions, as a general rule, government funding should only be availed of where necessary to avert possible market failures. Consider, for instance, the development of a consumer-facing application in a new and, as yet unproven, digital ecosystem. Private enterprise is unlikely to invest in developing such an app, considering that there is not yet a market for it. In these situations, the government could step in to fund its development to catalyse a demand.

The best example of this, in the Indian experience, is the government-funded BHIM app that virtually single-handedly kickstarted private sector interest in India’s digital payments infrastructure. Today, private payment service providers dominate the space, but had it not been for the government’s initial investment in the development and proliferation of BHIM, UPI may never have achieved the success it enjoys. The market failure here, was a missing market. Had the government not intervened, we might never have been able to develop the commercial ecosystem in the digital payments space.

Governments face soft-budget constraints that end up causing budget deficits, ultimately leading to “government failures’’. Philanthropic funding is often an appropriate alternative in these circumstances. It is not a coincidence that most open stacks tend to be initially funded by philanthropies. A case in point is MOSIP, the open source identity platform that offers technological building blocks for foundational identity programmes. MOSIP is being used by countries such as Ethiopia, the Philippines and Morocco to build their ID platforms. Other examples of community-driven initiatives include mapping services such as OpenStreetMap that offer geographic information systems that can subsequently be incorporated into digital ecosystems.

Modern digital ecosystems are typically modular, making it possible for various components of the ecosystem to be funded differently. In most instances, the edges of the ecosystem — the customer-facing apps and user interfaces through which users interact with the system — can be funded using private capital. This is the portion of the ecosystem that will benefit the most from the operation of market forces that will both encourage proliferation and incentivise innovation. On the other hand, core elements of the infrastructure (the registries that determine the roles and permissions of ecosystem participants) are susceptible to negative incentives like rent-seeking and nepotism.

While we can rely on private capital for these elements, care should be taken to safeguard them against unfavourable outcomes by putting in place regulatory oversight. In the context of technologically complex systems, this could be extraordinarily challenging, given that regulators often lack the competence to even understand the complex systems over which they have oversight. When Boeing designed the 737 Max, they gave the 40-year-old aeroplane design a software upgrade — introducing the new MCAS system that took so much control away from the pilots that it resulted in two crashes within a few months of its launch. While Boeing admitted, in court documents, to having withheld relevant information from the regulator, what was even more disturbing was that the Federal Aviation Administration (FAA) had virtually abdicated its responsibility, allowing Boeing engineers to prepare the safety analysis document themselves, confirming that the aircraft complied with FAA regulations. Since they did not fully understand how this fly-by-wire technology operated, the regulator had allowed the regulated entity to certify itself.

It is in order to avoid such situations that regulators need access to reliable institutional support that can help them deal with rapidly evolving standards in cutting-edge technical domains. Technical standards organisations perform this role, providing regulators with the advice they need to evaluate how existing standards need to evolve to both meet the demands of the market and keep up with improvements in technology. These institutions should ideally be funded using philanthropic capital to prevent regulatory capture by private entities while at the same time ensuring that the organisation has the level of sustained investment that it needs.

There is no standard prescription for the split between public, private and philanthropic capital in our digital ecosystems set-up. The complexity of these digital ecosystems requires us to arrive at an appropriate balance for each system that ensures that citizens are both empowered by technology while at the same time protected from its most harmful side-effects.

To paraphrase former Chinese leader, Deng Xiaoping, we need to cross this digital river while feeling the stones.

Rahul Matthan is partner at Trilegal and Prakhar Misra is PhD candidate at Johns Hopkins University 

The views expressed are personal

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