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Digital trade

How are governments responding to digital trade?

Digital trade upends the traditional relationship between states and companies. Here, we explore how governments are responding.

The gradual but inevitable move towards economic activity taking place as online services is increasingly important to businesses, who now have access to markets that were hitherto largely inaccessible for reasons of distance and a lack of economies of scale. This is important to their home states, who benefit from this activity through employment and taxation. However states, as regulators of their national markets, also face the practical and legal difficulties of regulating activities involving actors over which they lack traditional jurisdictional control.

Governments have responded by acting unilaterally both to capture the gains from digital trade and to protect their regulatory interests. Given the international dimensions of digital trade, since the 1990s states have also been engaged in international negotiations on the rules that should govern this activity. These negotiations cover distinct issues, some of which are more economic and some more regulatory in nature.

Regulatory interests

As elsewhere in trade law, however, even when market access is granted, it is always subordinate to exceptions permitting states to regulate in the public interest. And it is here that current trade negotiations are most important, as states seek to agree rules that recognise each other’s regulatory regimes and hence permit services to be supplied from abroad even if, in certain respects, they differ from services that could be supplied domestically. Here several aspects can be distinguished, depending on what it is that is sought to be regulated.

Service supplier profits. Traditionally, the activities of service suppliers are regulated in the country of consumption (where this is possible), but their profits are taxed in their home jurisdictions. For online service providers this is now changing, thanks to the imposition (or threatened imposition) by several countries of digital services taxes on the profits of foreign online companies operating within their jurisdiction (either directly, or via advertising, indirectly). The result is a revolutionary (from a tax perspective) OECD multilateral agreement via which large corporations can be taxed on their profits based on the location of revenue rather than the location of their establishment.

Service supplier qualifications. Regulating services is often more difficult than regulating goods because, for technical reasons, it frequently depends on regulating the supplier, for example by means of qualifications. It is possible, in many cases, for foreign service suppliers to meet the rules of the consumer’s jurisdiction, but it is also a great advantage if their home country rules can be recognised as ‘equivalent’. In theory this can be done via ‘mutual recognition agreements’ (sometimes called ‘regulatory cooperation’), although in practice these are relatively rare (some exist in the financial services sector). The difficulty boils down to two questions of trust.

  • First, can the importing jurisdiction trust the standards being applied in the exporting jurisdiction?
  • And second, can the importing jurisdiction trust the compliance mechanisms of the exporting jurisdiction?

For the importing jurisdiction to trust both the standards and the compliance mechanisms of the exporting jurisdiction is exceedingly rare. It typically requires harmonised standards, or at least the possibility of harmonised standards, and an overall control system, for example as in the European Union.

Ancillary recognitions. Associated with these types of mutual recognition, though not directly related to the supply of particular services per se, states are also beginning to enter into commitments to promote digital trade, for example by prohibiting spam, or recognising digital IDs or online legal transactions.

Data exports. Foreign service suppliers increasingly need access to data exported from a consumer’s jurisdiction to be able to provide their services those consumers (and indeed to others). Here the consumers’ states have three interests.

  • Economic: if states prevent data exports, they effectively prevent service imports. As with all protectionism, the theory runs that this is likely increase investment at home.
  • Data protection: states are reluctant to allow exports of personal data unless there are guarantees that it will not be misused.
  • National security: states are similarly cautious around exports of data to certain countries (either directly or by prohibiting entities from those countries having any control over domestic data). In practice, negotiations on this issue break down into a commitment to prevent data export prohibitions (eg via data localisation requirements) which is subject to an exception (of varying scope) when this is necessary for data protection or national security purposes.