Predictions for trade in a blockchain world

[Together with Alastair Berg and Brendan Markey-Towler this article was published at Machine Lawyering]

As goods move from producers to consumers, information about those goods must travel with them. Where did a product come from? Is this wine fake? How fresh is this lobster? Modern supply chains, however, are remarkably long and complex. This complexity makes it costly to produce trusted information about goods. Blockchain and other distributed ledger technologies are poised to help lower information costs, potentially expanding and reshaping global trade.

At first it isn’t clear why we should care about trade costs. Reducing trade costs might make our goods a bit cheaper, but what is the potential longer term impact? Finding new ways to bring down the costs of trade is important because it expands the number of trades that are possible, propelling growth and prosperity.

The standardised shipping container was invented mid-way through the last century. Alongside other new technologies such as air freight, it helped transportation costs plummet. Other technologies, such as the formation and success of international trade negotiation bodies (e.g. the World Trade Organization) lowered the regulatory costs of trade. Average worldwide import tariffs fell from around 8.6% in 1960 down to 3.2% in 1995.

Today a different form of costs dominates the frictions in global trade: information costs. We can think about goods as having different attributes: provenance, age, quality, physical location, and so on. Consumers often want to know a product’s provenance. Producers want to know who their final market consumers are. Governments want to know if goods comply with domestic regulations like biosecurity laws.

But where does this information come from? Who produces it and ensures its accuracy? Today we tend to rely on paper-based communications between hundreds of companies along a supply chain. Even when those communications are digitised, they spend much time within, and moving between, confined hierarchies.

As a new institutional governance technology for decentralised ledgers, blockchain might provide a better way. Coupled with other technologies such as the Internet of Things (IoT), blockchain can be applied as a governance mechanism to store and validate a ledger of information about goods.

It would be easy to suggest that blockchains will simply decrease the costs of supply chains and make consumer goods cheaper. In our recent working paper at the RMIT Blockchain Innovation Hub, we draw on economic theory to predict how blockchain might shift how and where we trade, leading to fundamental changes to globalisation.

First, we anticipate de-commoditization of economic goods. Many of the goods we buy are sold for the same price even where their underlying characteristics differ. Those goods are not sold in the same market because they are objectively the same, but because they cannot be economically or reliably differentiated due to information costs. We expect this over-commoditization to be most prominent in markets for luxury or perishable goods, where uncertainty is built into a single market price.

To the extent blockchain trade infrastructure provides deeper and more reliable information, goods can be de-commoditized and be sold in separate markets. Over time we expect price signals to disaggregate—put simply, there will be more prices—and ultimately facilitate better market coordination.

Second, blockchain trade infrastructure might shift economic power and therefore value to the polar ends of supply chains. Supply chains are plagued by information asymmetries—where some party holds information that another does not. These information asymmetries lead to market power. For instance, a primary producer of coffee in a developing economy might lack information about their final consumers or the price at which their coffee is eventually sold, restraining them from seeking new markets.

Information asymmetries persist for many reasons, one of which is a lack of incentives for actors along a supply chain to provide that information. By providing more transparency along the supply chain, blockchain might reduce information asymmetries for producers and consumers.

As a result producers of premium products might be able to charge premium prices, while consumers could more dynamically shift between different supply chains, for instance based on their appetite for organic produce. This suggests greater competition between suppliers of similar goods regardless of existing trade relationships.

Our final prediction is a reduced reliance on quality proxies, including national borders. As consumers we regularly rely on proxies to determine the quality and legitimacy of a product (such as brand reputations and production within national borders).

As uncertainty declines over the precise characteristics of a production, however, we would anticipate that the reliance on proxies as a measure of the quality of a product will diminish. Consumers will be able to more effectively rely on the specific attributes of a product. The longer-term effect might be to shift what products are produced within economies who currently suffer discrimination due to their reputation (perhaps for food and safety regulations).

We have outlined three predictions in this post. Those predictions are necessarily speculative and will play out through as an entrepreneurial and evolutionary process of search and discovery. What can we do in the meantime? Elsewhere our colleagues have suggested the need for open standards and a crypto-friendly policy sentiment, enabling entrepreneurs to build this new blockchain-based trade infrastructure—only then will we see if our predictions are correct.

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