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

Editor's Note

As the first report in the special commentary series "Digital Global Governance and Diplomatic Strategy," a commentary by Professor Seo Bong-gyo of Dongduk Women's University, analyzing the hegemony competition between the US and China in the digital finance sector, has been published. In this commentary, the author states that the US, which previously held hegemony in international finance, faced a decline in confidence regarding the stability of the dollar's value after the financial crisis. During this period, non-bank digital financial services, which were relatively free from regulation, experienced rapid growth. Conversely, since 2010, the Chinese government has been addressing the chronic problems of its financial system, which is largely characterized by the legacy of a planned economy and state-owned financial institutions, and has been challenging the global hegemony established by the US by fostering non-bank mobile payments led by Alipay. The author argues that amidst this international competition in digital global governance, South Korea's digital finance development lags behind international standards, emphasizing the importance of securing its own digital finance platform with competitiveness 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 the financial sector, particularly FinTech (Financial Technology), which refers to 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 cross-border e-commerce payments, international remittances, overseas stock trading, and foreign fund purchases, without needing to visit the 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 that of the United States. China is now expanding this mobile-based digital finance into international finance 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 decades, the United States has dominated international finance. The dollar held the status of the international reserve currency, and US financial institutions secured a competitive network connected by offline branches worldwide. In online international finance as well, US financial hegemony was firmly established decades ago by dominating the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system and the international credit card networks of Visa and Mastercard. Furthermore, international financial institutions established and led by the US, along with international laws ensuring the free movement of international capital, provided the foundation for the US financial system to be recognized as the 'global standard for international finance'.

However, since the global financial crisis originating from the US subprime mortgage crisis in 2008, concerns about the stability of the existing US-led international financial paradigm have grown. In particular, the massive issuance of dollars by the US in three rounds to overcome the global financial crisis, a policy known as quantitative easing (QE), has significantly weakened confidence in the stability of the dollar's value as the reserve currency. At that time, the US expanded its money supply by $3 trillion in the first round of QE, $6 trillion in the second round, and the supply of dollar currency was abnormally expanded through the third round of QE, which continued until the end of 2014.

Simultaneously, regulations on the soundness of US financial institutions, particularly 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 '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, especially network service companies in the IT industry, have begun to grow rapidly by offering innovative mobile financial services with the introduction of smartphones. PayPal, a leader in new digital financial services in the US, offers digital platform financial services that combine various FinTech services such as on- and off-line mobile payments, mobile asset management, and mobile lending into a single app. Starting as a subsidiary of the global e-commerce platform eBay, PayPal played a prominent role in international finance by 2010, providing online e-commerce payment services in over 100 countries in partnership with 25 currencies. In 2011, it launched mobile payment services for offline stores as well as online. Furthermore, it is leading mobile financial innovation by offering various O2O (Online to Offline) services that link online and offline.

It is noteworthy that PayPal is moving to introduce a new payment system in international finance that drastically reduces fees, rather than relying on the existing international financial system. For example, PayPal currently relies on the international payment system based on international credit cards for international payments. However, PayPal originally used a method where payment funds were deposited into a PayPal account and used for payment, known as the 'Escrow' method, essentially acting as an online virtual exchange. This involved the consumer (buyer) depositing money into a PayPal virtual account, and once the online e-commerce transaction was completed, the seller would receive the sales proceeds from the PayPal virtual account. However, international payments, unlike domestic payments, 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 are being developed, offering drastically reduced fees compared to traditional bank international remittances. PayPal has also announced that it will introduce new international payment methods to replace the existing costly international credit card-based payment systems for international payments 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 anticipated that international transactions between Libra currencies, with no currency exchange or remittance fees, could mark a revolutionary turning point in international digital finance transactions. In particular, unlike other blockchain-based cryptocurrencies such as Bitcoin, Libra was explained to be linked to real assets such as dollars and various international currencies held by Facebook, thereby ensuring the stability of Libra's currency value.

Although the launch of Libra has been postponed due to strong opposition from existing financial institutions and concerns about its potential use for illegal international money laundering, it is clear that traditional offline bank-based international payments in the field of international finance 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 payments, 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 system?

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 China's financial system, characterized by the legacy of a planned economy and a 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, particularly 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 started in 2004 as an internet payment system for Alibaba, China's largest e-commerce platform. Since then, based on its absolute dominance in internet e-commerce payments, Alipay has rapidly expanded its business areas to include mobile online payments, mobile offline simple payments, O2O businesses, and mobile financial asset 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 asset management product, 'Yu'e Bao,' in 2013. This was because the Chinese government pursued a policy objective of improving the underdeveloped existing Chinese financial system through digital finance and responding to global digital finance platforms.

Non-bank mobile payments like 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 increased 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 allowed 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 does so in 24 countries worldwide.

Chinese tourists with Alipay accounts can purchase goods, use public transportation, and visit tourist attractions abroad without separate currency exchange. Although it is a slightly exaggerated promotional slogan, it is true that an era has arrived where Chinese people 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 conducted through the China Inter-bank Payment System (CIPS), also known as the RMB international payment system, which began in October 2015. To promote the internationalization of the RMB, the Chinese government introduced the RMB international payment system to enable real-time processing of RMB trade settlements, RMB international investments, and RMB remittances by overseas financial institutions and individuals. Currently, CIPS operates 24-hour international payment services in two phases and has secured 31 direct participating institutions and 701 indirect participating institutions, both domestically and internationally, to conduct global RMB digital international payment operations. The information and 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 China's mobile digital platforms are being actively promoted for overseas expansion, contradictory policies are being implemented that restrict US global digital financial platforms from providing financial services within China, both directly and indirectly. 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 servers within China, and censorship is possible at the request of the Chinese government. Violations can result in fines and even business suspension, making it a stringent law.

China's Cybersecurity Law goes beyond merely protecting online personal information; it signifies that the Chinese government perceives cyberspace as a 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 in the future.

The US is striving to secure its hegemony in the digital international finance sector, mirroring its dominance in traditional offline international finance. The US, which already possesses businesses like PayPal, Facebook, Google, and Amazon that provide global network services to people worldwide, undoubtedly holds an advantageous position in digital international finance. However, in the mid-to-late 20th century, the US held absolute superiority 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 significantly weakened since the 2008 global financial crisis. The US must persuade others of the necessity and utility of deregulation in cyberspace against the logic of 'data sovereignty' advocated by countries protecting their domestic digital financial businesses. Furthermore, the challenge posed by Chinese digital finance businesses actively pursuing internationalization, leveraging the RMB and their 1.4 billion users, is considerable.

New Digital International Finance Standard Competition and South Korea's Strategic Choice

The international competition to dominate the standards in digital international finance will determine who will be the next economic superpower. While 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 has enacted the 'General Data Protection Regulation (GDPR)' in 2016, which came into effect in 2018. The EU, also from the perspective of 'data sovereignty,' regulates US-based platform businesses operating in EU countries from using European consumers' financial information to develop new business competitiveness, such as big data. In 2019, France's personal data protection authority ruled that Google's personalized advertising violated the provisions of this law and imposed a fine of 50 million euros (approximately 62.4 billion Korean won).

South Korea's digital finance, particularly mobile financial services, is considered significantly underdeveloped compared to international standards. In South Korea's non-cash digital payments, credit cards have the highest proportion, but credit cards are associated with high transaction fees and have limitations in fostering new FinTech innovations such as O2O and mobile asset management. Concerns are also raised about the possibility of US-based credit card companies like Visa and Mastercard using Korean financial transaction information as a driving force for big data and AI businesses.

Recently, while the MyData business, which promotes the free use of personal financial information, is being pursued in South Korea, the need for 'data sovereignty' to strengthen 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, while China and Europe are responding with the defensive logic of data sovereignty and striving to enhance their digital international finance 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 strategy most beneficial to us. Finally, to gain favorable conditions in making these strategic choices, we must not forget that it is advantageous to secure our own digital finance platform with significant competitiveness in the digital finance sector. ■

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

■ Responsible Editor: Lee Young-hyun, EAI Research Fellow

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

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