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Featured AIQ Podcast: Risk and resilience in an age of uncertainty

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What does a fractured internet mean for investors? Find out more in this episode.

[Intro music]

Narrator

John Perry Barlow was a classic American Renaissance man. After growing up on a cattle ranch founded by Mormon pioneers, he became a poet, essayist and political activist. In his spare time, he wrote lyrics for psychedelic rock band The Grateful Dead.

Barlow was also an early advocate of the internet. In 1996, he published a paper titled “A Declaration of Independence of Cyberspace”, which summed up the idealistic view of the internet as the technology became mainstream.

John Perry Barlow

Governments of the Industrial World, you weary giants of flesh and steel, I come from Cyberspace, the new home of Mind. On behalf of the future, I ask you of the past to leave us alone. You are not welcome among us. You have no sovereignty where we gather…Your legal concepts of property, expression, identity, movement and context do not apply to us.

Narrator

Barlow, who died in 2018, would not have approved of the direction the internet is now taking. While the coronavirus pandemic has highlighted modern society’s reliance on online tools, it is also clear that the freedoms of the early internet have been sharply curbed.

Big tech companies have sectioned off cyberspace into “walled gardens”, where users are profiled and bombarded with advertisements. Governments have wrested back control of online spaces with firewalls and surveillance technology.

The result is no longer a frictionless platform but an increasingly fragmented online realm. Global companies must adapt their operations to different regulatory regimes and may even be barred from some countries altogether, due to governments’ efforts to protect their “cyber sovereignty”. In this episode of the AIQ podcast, we’ll explore what the era of the splinternet means for investors.

[Intro music fades out]

[Sound effects: gunfire, explosions, fighter planes]

The story of the internet starts with war. The early infrastructure of the net was built by Silicon Valley engineers, working with technology inherited from the US government’s military projects. But it did not become the global communications system we know today until computer scientist Tim Berners-Lee invented the World Wide Web in 1989.

Berners-Lee wanted the web to be open and free, but before long big companies and states began to reassert control. The Edward Snowden revelations of 2013 showed intelligence agencies in the US and elsewhere had long been working with tech companies to monitor citizens’ online activity. Here is Snowden in conversation with John Perry Barlow in 2011.

Edward Snowden

The game has changed from where law enforcement investigates criminals and specific targeted threats, to where they investigate citizens, they are investigating all of us, and that’s a real problem, because we fought a war to have rights like our Constitution, our Fourth Amendment. That says not only can you not search our communications without a warrant, but you can’t seize them in the first place and create a giant database of all our activities, and then go back and search them just Because You Want To Know What’s Going On.

Narrator

It is not surprising governments would want to regulate the lawless spaces of the internet and crack down on criminal activity online. For authoritarian states, the use of online messaging in sparking civil unrest posed a direct threat.

China developed its formidable “Great Firewall”, which limits access to websites the Communist Party deems subversive, and other states, including Russia and Iran, have adopted similar methods.

But companies also played a role in the balkanisation of the network. While they benefited from the globalisation of the internet and rising numbers of potential customers, technology firms tried to keep users on their own platforms so they could monetise a captive audience using targeted advertising algorithms.

Here’s Gideon Rose, editor at Foreign Affairs magazine, discussing this trend in conversation with Bloomberg TV.

Gideon Rose

What happens is, the large private tech companies take over large portions of the internet and become an oligopoly running things on their own; government regulators don’t really get involved, and the internet takes on its own life. […] Various people start to push back against the problems in the internet: the Chinese  try to succeed with cyber-sovereignty in their own sphere, the Europeans try regulation with GDPR, the Indians try to build a new internet from the ground up on a  more public good basis, the Americans sit around wondering, “Gee, can we control the tech companies?” But Americans are so embedded in an Anglo-American view of liberal capitalism in which government lets the private sector do its stuff, that American policy has allowed the internet to create problems and now other people are coming in to fix those problems.

Narrator

In a 2019 paper, “The Four Internets: The Geopolitics of Digital Governance”, academics Wendy Lee and Kieran O’Hara argued the internet is being carved into four competing systems, led by various governments or private entities.

First is the “Open Internet” of Silicon Valley, where tech engineers and entrepreneurs retain an idealistic vision of a universal web system.

Second is the “Commercial Internet”, associated with policymakers and commercial lawyers based in Washington DC, who emphasise the need to protect corporate interests and intellectual property rights.

Third is “Beijing’s Authoritarian Internet”, which restricts user freedoms in the interests of political stability.

Fourth is the “Bourgeois Internet” of Europe, which puts greater emphasis on user privacy and looks on corporate monopolies with more suspicion than the other models. Each of the internets is threatened by “spoilers”, such as hackers and Russian state-sponsored propaganda bots.

As Lee and O’Hara argue, these different visions of the internet are presently “coexisting, and may continue in this way for some time. It is possible, however, that any of these internets may fall by the wayside, and also that any one of them might become dominant.”

The most obvious conflict is between the US and Chinese models of the internet.

Donald Trump

We confronted untrustworthy Chinese technology and telecom providers. We convinced many countries – I did this myself for the most part – not to use Huawei, because we think this is an unsafe security risk. I talked many countries out of using it; if they want to do business with us they can’t use it.

Narrator

That was outgoing US president Donald Trump, speaking in June 2020 about his government’s efforts to prevent Chinese technology firm Huawei from building 5G infrastructure for the US or its allies. And geopolitical concerns have also obstructed the international ambitions of two other innovative Chinese tech platforms: Tencent’s WeChat and TikTok, a video streaming service developed by Beijing-based ByteDance.

In August, Trump signed an executive order that imposed commercial restrictions on both apps and ordered ByteDance to sell TikTok’s US operations.

Here’s Alistair Way, head of emerging market equities at Aviva Investors, to explain more.

Alistair Way

TikTok has been the first genuinely global emerging market internet phenomenon. And probably did it at the wrong time given the extra level of security and scrutiny on this sort of business model. […]  A lot of the tech advantage of Tiktok links back in to the AI discussion […] it’s the way it manages in a very unobtrusive fashion to come up with an almost hypnotically engaging stream of content that is tailored to the user’s preferences. It’s quite astounding; the way it’s managed to create a product that is arguably more appealing than Facebook, in a short space of time. In terms of the customer data it collects, it does seem to be pushing it a bit; a lot of social network sites collect a lot of your mobile data, but it is worse than average, and in the current geopolitical climate, to have a Chinese-owned entity taking massive market share from Western competitors with maybe more uncertainty about where the data ends up after it is collected, you can understand why scrutiny has ramped up on this company.

Narrator

Within China, tech companies have benefited from government support and unprecedented access to user data, which they are using to power innovative AI platforms – we could see more companies like TikTok become domestic champions, even if they are restricted from operating abroad.

Here’s Rebecca Fannin of research firm Silicon Dragon Ventures, interviewed on CNBC.

Rebecca Fannin

I think in AI we’re going to see a separation in how fast it’s implemented. Right now, the US has the lead in R&D and research and development, but China is moving much more swiftly in getting AI implemented into mobile payments, into all kinds of security systems. The US is slower to have that kind of up-take. So we are starting to see this separation. I think whichever market gets ahead in AI plus 5G will have a real advantage in the future of technology and will have a leadership position. We are seeing a separation now in many important sectors.

Narrator

With Chinese firms blocked from doing business in the US, they are increasingly looking for opportunities in emerging economies. China’s Digital Silk Road initiative offers cheap loan financing for poorer countries, many of them in Africa, to develop their internet infrastructure using loans from Chinese banks and hardware provided by Chinese companies such as Huawei.

Huawei has also teamed up with Chinese state-owned organisations to press for a fresh technical standard for the internet, known as “New IP”, at the United Nations’ International Telecommunication Union (ITU). Huawei says this model for the internet’s architecture would allow for faster internet speeds; critics say it is a more centralised, top-down system that would give nation states like China more control over citizens’ access to the network.

Meanwhile, both US and Chinese firms are looking to make up for their lack of access to each other’s markets by vying for customers in third countries such as Indonesia, Thailand and Vietnam, whether through partnerships with local companies or by directly offering their own services.

But in these markets, too, the splintering of the internet into national regimes is apparent, and domestic firms have been able to fend off competition by leveraging their local expertise in some sectors, especially logistics and e-commerce. Here’s Alistair Way.

Alistair Way

Certainly, for e-commerce, retailing and logistics, local expertise is absolutely key; it seems like a local business or at least a business where local players have a decent chance of fighting back, or fighting off Amazon or Alibaba.

Narrator

The mobile-led internet model in emerging markets has powered a trend for “verticalization”, which deepens the splintering effect. Rather than access an all-purpose search engine on a web browser, people in emerging markets increasingly seek out products and services using dedicated apps. This can create barriers for other tech companies hoping to generate advertising revenue, argues Mikhail Zverev, head of global equities at Aviva Investors.

Mikhail Zverev

If you compare the US and China, ignoring the government involvement and censorship access to markets for the moment, one of the things people thought about five, six years ago was: they looked at Baidu which is, for lack of a better description, the Google of China. And they extrapolated in Baidu the journey Google has made, and they said, “Hey this is the dominant search engine, nothing else compares, and look how much value accrued to dominant search engines in the West; the same should apply to Asia.” But investors were deeply disappointed by subsequent events. It turns out a lot of the value Google accessed wasn’t accessible to Baidu because consumers behaved differently and the industry structure developed differently.

Narrator

Consumers in emerging markets access the internet almost exclusively using mobile phones; they tend to migrate to vertically integrated apps and thereby cut off advertising revenue streams from tech giants that operate more universal platforms, like search engines. There are signs younger generations in the West may be behaving in the same way, which would benefit tech firms that can verticalize on specialised digital platforms.

But tech giants in the West also need to be wary of social and political shifts. Both major US political parties have been critical of the power of the technology giants and spoken openly about the prospect of breaking them up.

On October 6, 2020, a report from the Democrat-controlled House of Representatives found Amazon, Apple, Google and Facebook had all abused their market power. It recommended antitrust law be rewritten so that tech companies can be forced to restructure if they wield dominance across multiple business lines. In the same month, the Department of Justice brought antitrust proceedings against Google, alleging it has engaged in monopolistic practices to favour its search engine.

The politics may reflect shifts in societal attitudes – potentially a more important hazard to Google than the antitrust case itself, which has barely registered by the market.

[Clip from the trailer for Netflix series The Social Dilemma; dramatic music]

Quotes from trailer

When you go to Google and type “Climate Change Is…” you’re going to see different results depending on where you live and what Google knows about your interests. That’s not by accident. It’s a design technique. What I want everyone to know is that everything you do online is being watched, being tracked, every single action you take is carefully monitored and recorded…

[Dramatic music fades out]

Narrator

One of the biggest Netflix hits of 2020 is a documentary called The Social Dilemma, which exposes the methods by which Big Tech gathers data on users and manipulates their behaviour to better target them with advertisements. Zverev draws an analogy with a similar documentary, Michael Moore’s Sicko, released in 2007, an indictment of the US healthcare system that encapsulated growing public anger at rising drug prices and insurance costs. Regulation soon followed.

Mikhail Zverev

What this tells me is that if society is really annoyed by you it doesn’t matter whether you are actually breaking laws; society will find a way through the political mechanisms to make your life difficult. I think The Social Dilemma/regulatory attention is a precursor to something like that; maybe new legislation, maybe a new antitrust policy. So this ‘social license to operate’ question looms large.

Narrator

In Europe, regulators have shown more willingness to crack down on Big Tech, notably in the area of content moderation, where US regulators are wary of interfering due to concerns over freedom of speech. Social media companies have become notorious for allowing hate speech and disinformation to thrive on their platforms and European governments have introduced new laws to tackle the problem.

The European Commission is drawing up legislation that will force tech giants to remove illegal content or face the threat of sanctions under a “Digital Services Act”, due to be unveiled at the end of 2021. A crucial part of this is the right to privacy and individual data ownership.

Margrete Vestager

Fundamentally, we share the same goals. And I think that is obvious. We want to better protect citizens when they use the internet, whether that is a protection against illegal goods, services, content online as it was put. We need to make sure that as we feel safe offline, we should feel safe online, and also better secure freedom of expression online. And this, of course, as you have heard already, this is a tricky balance to strike.

Narrator

That was Margrete Vestager , European Commissioner for competition, discussing the proposed legislation in the European Parliament.

Tighter regulations may create a more distinct regulatory regime in Europe. Tech companies could be forced to spend more on technology or human labour to moderate content on their platforms, hurting their profit margins.

The European Union also looks likely to introduce new laws to protect individuals’ data ownership and privacy, building on the General Data Protection Regulation, or GDPR, introduced in 2018.

Pending regulation may compel big technology firms to allow interoperability; in other words, making it easy for users to shift their data between platforms. This would punch holes in the “walled gardens” that contribute to the splintering of the internet.

From a commercial perspective, much depends on how far these different models of the internet continue to diverge.  For now, the direction of travel seems clear. In the US and especially Europe, Big Tech firms will need to tread more carefully as concerns over content and data ownership grow, potentially opening up opportunities for rival platforms that offer better security and data-privacy protections.

These same concerns over privacy will limit the overseas growth of China’s internet giants in the West. But behind the Great Firewall, they will continue to develop innovative systems and may outstrip Western firms in areas such as artificial intelligence.

In other emerging markets, companies that can attract mobile internet users to vertically integrated platforms will be able to better compete with global internet firms. This could create a more diverse internet ecosystem globally.

But even as we all adapt to the splinternet, perhaps we shouldn’t lose sight of the idealistic principles that underpinned the free growth of the World Wide Web. A final word from Tim Berners-Lee, who spoke to the World Economic Forum about where his invention goes from here.

Tim Berners-Lee

There have always been forces to try and control the internet. When you’re the government of a country it’s tempting to want to control the internet within that country. Trouble is, it doesn’t work, because the internet is not a thing of countries. You can put in barriers, you can put in firewalls. But as you do that, suddenly your country, your people, your entrepreneurs, your teachers, have lost their voice. […] Whether the internet is an open space or a closed space I am not going to predict. It all depends on us, what we decide to do and the decisions we make now.

[Outro music]

Narrator

Thank you for listening to the AIQ podcast. Read the latest issue of AIQ magazine at our website, www.avivainvestors.com. Please look out for future episodes and feel free to subscribe through any of the major podcast channels.

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