Balkanization Is Bad for Facebook’s Business

(Bloomberg Opinion) -- The internet, once a freewheeling global network, is becoming balkanized into national spheres of influence. This could be bad for both cross-cultural communication and U.S. tech companies.

China has long protected its local internet, censoring speech behind what has become known as the Great Firewall. The government blocks U.S.-based services such as Google, Facebook and Twitter, and closely monitors the local Chinese versions. Other authoritarian and quasi-authoritarian countries -- Iran, Turkey, Pakistan, Vietnam, Ethiopia – do the same. And Russia recently passed a so-called sovereign internet law that makes it much easier for the government to monitor and control online content.

Now democracies may be joining in. India just banned 59 of China's largest internet apps, including social video sharing service TikTok, reflecting rising tensions between the two giant Asian countries. It has also shut off internet to regions experiencing government crackdowns or unrest, such as Jammu and Kashmir in 2019. In Europe, major rules such as the General Data Protection Regulation are forcing internet companies to operate differently in different regions. Though this doesn't officially ban or censor U.S.-based sites like Facebook, it does present an obstacle that could end up inhibiting the flow of information.

This was probably inevitable. Different cultures perceive concepts such as privacy differently. And as U.S. global hegemony gives way to a more multipolar world, countries are going to assert their sovereignty by refusing to play by U.S. rules. Further unrest, like the protests that rocked the world in 2019 or tensions between countries such as China and India, are likely to accelerate the trend towards digital division.

This could be tough on U.S. tech companies. Facebook, Twitter, Instagram and YouTube don't owe their profitability to superior technology, other than some techniques for managing large amounts of user data. They make money because they have a lot of eyeballs to which they can deliver advertisements.

And they have those eyeballs because of network effects. It's easy to make a Twitter clone -- Gab tried it a while ago, and a new entrant called Parler is trying it now. But it's incredibly hard to get people to switch, because the first people who make the jump will find themselves mostly alone, with everyone they know and want to read still back on Twitter. Similarly, people use Facebook, Instagram, Snapchat, and other social media services because everyone else does.

Captive advertising targets translate into enormous profits. Facebook, Inc., which dominates the social media landscape, has a profit margin that typically ranges between 20% and 40%. Its market cap as of early July was about $647 billion, or 2.6% of the entire S&P 500.

Regional balkanization, though, slices through network effects. If services like Facebook are banned in some countries and heavily restricted in others, users will have less company. Most people's contacts and friends will tend to be in the same country, but not all. And outright bans will cut some services off entirely from huge markets like China, while restrictions like GDPR will force them to invest in expensive localization.

This is an unfortunate side effect of nationalism and unrest. But it's also reason to worry about a technology industry whose profitability stems mostly from network effects, not know-how. Actual innovations, like Intel Corporation's semiconductor manufacturing processes, Amazon.com, Inc.'s cloud computing systems, or Google LLC's machine learning algorithms give these companies some clout:  if a country decides it doesn't want to buy Intel's chips, it will suffer a real economic penalty. But if a country decides to create its own Facebook clone, it will lose little, while Facebook's American owners and workers will lose a lot.

A free and open global internet may one day reemerge. In the meantime, U.S. companies and policy makers should think about how to invest in products whose value isn't so subject to the whims of foreign authorities.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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