[EAI Commentary] <Response Strategies for Global Digital Governance> US-China Financial Hegemony Competition and China's Challenge in Digital International Finance

Editor's Note

This is the first report in the special commentary series "Digital Global Governance and Diplomatic Strategy." Professor Seo Bong-kyo of Dongduk Women's University's commentary, which analyzes the hegemony competition between the US and China in the digital finance sector, has been published. In this commentary, the author explains that the US, which held the position of hegemon in the existing international finance sector, faced a decline in confidence regarding the value stability of the dollar after the financial crisis. During this period, non-bank digital financial services, which were relatively free from regulation, experienced rapid growth. Conversely, the author argues that since 2010, the Chinese government has been addressing the chronic problems of its financial system, which is largely composed of state-owned financial institutions and carries legacies of a planned economy. By fostering the growth of non-bank mobile payments led by Alipay, China is challenging the global hegemony established by the US. Within this international competition in digital global governance, the author assesses that South Korea's digital finance development is lagging behind international standards and emphasizes the importance of securing its own digital finance platforms with competitive capabilities in the digital finance sector.

The development of digital networks is expanding the scope of people's economic and industrial activities globally. The digitalization of finance, particularly FinTech which signifies the advancement of mobile finance, is also blurring the cross-border boundaries of financial services.

In the past, financial services were conducted based on offline branches of financial institutions registered as legal entities within a country. However, new FinTech financial services based on global digital networks enable access to various financial services such as payment for international e-commerce, international remittances, trading foreign stocks, and purchasing overseas fund products, without needing to visit offline branches of financial institutions. Individuals' smartphones function as personalized branches of separate, independent financial institutions, offering new and diverse international financial transactions.

China's rise in the digital finance sector is already well-known. The scale of China's mobile payments, represented by Alipay, has been overwhelmingly the world's largest for several years, tens of times larger than that of the US. China is now expanding this mobile-based digital finance into the international finance arena and is boldly challenging the global hegemony established by the US in the field of digital international finance.

Weakening of US International Financial Hegemony and Dollar Credibility

For the past several decades, the US has dominated the international finance sector. The dollar held the status of the international reserve currency, and US financial institutions secured network competitiveness connected by offline branches worldwide. In the online international finance sector as well, US financial hegemony was firmly established decades ago by dominating the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system and the international payment credit card systems of Visa and Mastercard. Furthermore, international financial institutions established and led by the US, along with international laws guaranteeing the free movement of international capital, formed the basis for the US financial system to be recognized as the 'global standard for international finance'.

However, since the global financial crisis stemming from the US subprime mortgage defaults in 2008, concerns about the stability of the existing US-led international financial paradigm have grown. In particular, the credibility of the dollar's value stability has been significantly weakened by the large-scale dollar issuance, known as quantitative easing (QE), conducted by the US in three phases to overcome the global financial crisis. At that time, the US expanded its money supply by $3 trillion in the first QE, $6 trillion in the second QE, and the supply of dollar currency expanded abnormally through the third QE, which continued until the end of 2014.

Concurrently, regulations on the soundness of US financial institutions, especially large banks with global networks, were strengthened. Examples include regulatory enhancements such as the 'Dodd-Frank Wall Street Reform and Consumer Protection Act' of 2010 and the 'new capital ratio measurement methods.' It was precisely during this period that non-bank digital financial services, which were relatively free from regulation, began to grow rapidly.

Rapid Growth of Non-Bank Digital International Financial Services

Since 2010, non-financial companies, particularly network service companies in the IT industry, have experienced rapid growth by offering innovative mobile financial services with the introduction of smartphones. PayPal, a leader in new digital financial services in the US, provides digital platform financial services that combine various FinTech services such as on- and offline mobile payments, mobile asset management, and mobile lending into a single app. PayPal, which began as a subsidiary of the global e-commerce platform eBay, played a prominent role in international finance by 2010, offering online e-commerce payment services linked to 25 currencies in over 100 countries worldwide. In 2011, it launched mobile payment services not only online but also in offline stores. Furthermore, it is leading mobile financial innovation by providing various O2O (Online to Offline) services that link online and offline.

What is noteworthy is PayPal's move to introduce a new payment system in international finance that offers significantly reduced fees, deviating from the existing international financial system. For instance, PayPal currently relies on the international payment system based on international credit cards for international settlements. However, PayPal originally used a method where payment funds were deposited into a PayPal account and used for payment, known as the 'Escrow' method, functioning as a type of online virtual exchange. This involved consumers (buyers) depositing money into a PayPal virtual account, and upon completion of an online e-commerce transaction, sellers would receive payment from the PayPal virtual account. However, international payments, unlike domestic ones, involve complex issues related to international remittances, currency exchange, and exchange rate risks, which led to the use of payments via international credit cards rather than the escrow method.

However, over the past few years, non-financial companies worldwide have been developing new and lower-fee digital international financial services. For small international remittances, solutions like MoneyGram have been developed, offering significantly reduced fees compared to traditional bank international remittances. PayPal has also announced its intention to introduce a new international payment method to replace the existing, high-fee international credit card-based payment system for international settlements from 2020 onwards.

Furthermore, in early 2019, Facebook announced plans to introduce a new digital international payment currency called Libra. The plan was for Facebook users worldwide to deposit Libra currency into their Facebook accounts and use it for international remittances and international transactions of digital goods such as music and videos. It was projected that international transactions between Libra currencies, free from currency exchange or remittance fees, could mark a significant turning point in international digital finance transactions. Notably, unlike other blockchain-based cryptocurrencies like Bitcoin, Libra was explained to ensure the stability of its value by being linked to real assets such as dollars and various international currencies held by Facebook.

Although Libra's launch has been postponed due to strong opposition from existing financial institutions and concerns about its potential use for illicit international money laundering, it is clear that international payments based on traditional offline banks are rapidly transitioning to new digital international financial systems. It is possible that we will soon enter an era where we can use various online financial services, such as international remittances, international trade settlements, and investments in international financial products, at very low fees, without going through banks or international credit cards. Will the US, and by extension the dollar, still maintain hegemony in this newly emerging digital international financial order?

Rapid Growth of Digital Finance Led by Chinese Non-Financial Companies

China's financial system and financial institutions were very backward. The chronic problems of the Chinese financial system, stemming from the legacy of a planned economy and its focus on state-owned financial institutions, are still considered difficult to resolve. However, since 2010, China has been experiencing the fastest growth in the world specifically in the digital finance sector.

China's digital finance has been developed and led by non-financial network service companies such as Alibaba and Tencent. Alipay originated in 2004 as the online payment system for Alibaba, China's largest e-commerce platform. Since then, leveraging its absolute dominance in e-commerce payment, Alipay has rapidly expanded its business areas to include mobile online payments, mobile offline simple payments, O2O businesses, and mobile financial wealth management.

Alipay secured an advantageous position in negotiations with local Chinese banks, which had underdeveloped digital finance infrastructure, regarding fees and business areas. During this process, the Chinese government allowed Alipay to be used for public service fee payments starting in 2008 and resolved the opposition from existing banks to the launch of Alipay's new mobile wealth management product, 'Yu'e Bao,' in 2013. This was because the Chinese government pursued policy objectives to improve the outdated existing Chinese financial system through digital finance and to respond to global digital finance platforms.

Non-bank mobile payments, such as China's Alipay, have grown rapidly, with an average annual growth rate (CAGR) of 119% between 2015 and 2018. Due to this rapid growth, the proportion of non-bank mobile payments in total non-cash digital payments surged from 0.5% in 2015 to 4.5% in 2018. In 2018, mobile payments by non-bank payment providers accounted for 64% of mobile payments by banks, playing a significant role in the Chinese financial system.

Internationalization of Chinese Digital Financial Services

Since 2010, the Chinese government has permitted mobile digital payment platforms like Alipay to conduct international payment operations. As of the first half of 2018, Alipay provides mobile international payment services in over 40 countries worldwide, and Tencent's WeChat Pay offers them in 24 countries.

Chinese tourists with Alipay accounts can purchase goods overseas, use public transportation, and visit tourist attractions without separate currency exchange. Although it may be a slightly exaggerated promotional slogan, it is true that an era has arrived where Chinese citizens can enjoy overseas travel with just their mobile phones.

The Chinese government is also actively supporting the internationalization of these mobile payment services. At the Two Sessions (Lianghui) held in Beijing in March 2018, mobile payments were mentioned as one of the representative products for overseas expansion from China. Arguments have been raised among Chinese scholars that Chinese-standard mobile payments should become the international standard, replacing credit card international payment systems developed by the West in the past, such as Visa and Mastercard.

Particularly noteworthy is that these Chinese mobile digital international payments are being processed through the China Inter-border Payment System (CIPS), which began in October 2015 for the international settlement of the Chinese Yuan. To promote the internationalization of the Yuan, the Chinese government introduced the CIPS to enable real-time processing of Yuan trade settlements, Yuan international investments, and Yuan remittance payments by overseas financial institutions and individuals. Currently, CIPS operates 24-hour international payment services in its second phase and handles global Yuan digital international payment operations with 31 direct participating institutions and 701 indirect participating institutions in China and abroad. The communication networks and GPS (Global Positioning System) services used by Chinese digital finance businesses also utilize China's independent systems rather than those of the US.

Conflict Between China's Cybersecurity Law and US Deregulation of Networks

While the overseas expansion of Chinese mobile digital platforms is being actively pursued, contradictory policies are being implemented, directly and indirectly restricting global digital financial platforms from the US from providing financial services within China. A representative law is the 'Cybersecurity Law' (网络安全法), which China has been implementing since June 2017.

This law restricts overseas digital financial businesses from providing financial services within China or utilizing such information in fields like Artificial Intelligence (AI). Network platform operators providing digital financial services to Chinese citizens must store collected information on domestic Chinese servers, and censorship is possible at the request of the Chinese government. Violations can result in fines or even business suspension, making it a stringent law.

China's Cybersecurity Law goes beyond simply protecting online personal information; it signifies that the Chinese government perceives cyberspace as territory where its sovereign power is exercised. It presents the concept of 'data sovereignty,' asserting that information collected or processed while providing digital network services to Chinese citizens must belong to China. In the digital finance sector, data is the driving force for AI, O2O businesses, and new financial innovations. The competition between China and the US to secure this data is expected to intensify.

The US is striving to secure its dominance in the digital international finance sector, mirroring its traditional hegemony in offline international finance. While the US possesses businesses like PayPal, Facebook, Google, and Amazon that provide global network services to people worldwide, it is true that the US holds an advantageous position in digital international finance. However, in the mid-to-late 20th century, the US held an absolute advantage in international political and diplomatic capabilities, and the status of the dollar as the reserve currency was stable, allowing international standards to be established relatively easily.

However, in the 21st century, for the US to establish international standards in digital international finance, there are significant challenges to overcome. International confidence in the stability of the dollar's value has considerably weakened since the 2008 global financial crisis. The US must persuade others of the necessity and utility of network deregulation in the face of arguments for 'data sovereignty' aimed at protecting its domestic digital financial businesses. Furthermore, the challenge posed by Chinese digital financial businesses actively pursuing internationalization, armed with the Yuan and 1.4 billion users, is formidable.

Competition for New Digital International Financial Standards and South Korea's Strategic Choices

The international competition to dominate the standards in the digital international finance sector is determining who will be the next economic superpower. Although the US already possesses global network platform businesses, they face difficulties due to regulatory barriers in various countries precisely because many nations are reluctant to easily concede international standards for these digital financial platforms.

Not only China but also Europe enacted the 'General Data Protection Regulation' (GDPR) in 2016, which came into effect in 2018. The EU, from the perspective of 'data sovereignty,' regulates US-based platform businesses operating in EU countries from using financial information of European consumers to develop new business competitiveness, such as big data. France's personal information protection authority fined Google €50 million (approximately 62.4 billion Korean won) in 2019 for violating the law with personalized advertising.

South Korea's digital finance, particularly its mobile financial services, is assessed to be significantly underdeveloped compared to international standards. In South Korea's non-cash digital payments, credit cards have the highest proportion. However, credit cards have high transaction fees and limitations in evolving into new FinTech innovations like O2O and mobile wealth management. Concerns are also raised about the possibility of US-based credit card companies like Visa and Mastercard utilizing the financial transaction information of Koreans as a driving force for big data and AI businesses.

Recently in South Korea, while the MyData business, which promotes the free utilization of individuals' financial information, is being pursued, the necessity of 'data sovereignty' for strengthening the competitiveness of Korean platform businesses is also being raised. This issue is not merely a matter of domestic policy direction. The US, having already secured sufficient global network platforms, is promoting deregulation on networks as the standard for digital international finance. In contrast, China and Europe are responding with the defensive argument of data sovereignty while striving to enhance their digital international financial competitiveness.

International standards can ultimately be secured with the support of neighboring countries. South Korea must also strategically re-evaluate the importance of this issue and choose the most desirable strategy for itself. Finally, we must not forget that to gain advantageous conditions in making these strategic choices, it is beneficial for us to secure our own digital financial platforms with considerable competitiveness in the digital finance sector. ■

■ Author: Seo Bong-kyo_ Professor of Chinese Studies at Dongduk Women's University. He holds a Ph.D. in Economics from Seoul National University and previously served as a Senior Researcher at the Overseas Business Research Team (specializing in Chinese finance) at Samsung Financial Research Institute and as a Senior Researcher (specializing in Chinese economy) at LG Economic Research Institute. His main research areas are the Chinese economy and Chinese finance.

■ Managed and Edited by: Lee Young-hyun, EAI Researcher

Inquiries: 02 2277 1683 (ext. 207) I ylee@eai.or.kr

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