Innovation and the Regulatory State

robida 1882 full paleo futureLast post I argued that there are no economic or brain-power limits to innovation. That the single factor holding back innovation is simply the policies we choose.

This isn’t just speculation: we can actually look back to our own recent technological “Golden Age” in the late 1800’s. Indeed, when we laugh today at the optimism of 1880 or 1900 visions of the future, it’s only because we have failed to keep the innovation engine humming the way people back then took for granted.

So what changed, exactly?

I’d argue that the single most important policy shift, the one that both ended that Golden Age and that continues to hold us back, is the rise of the regulatory state. The replacement of common-law tort as quiet and elegant regulator with brutal, clumsy, even corrupt fiat regulation. Giving us the incestuous and destructive corporatism of today that drives Americans across the spectrum — from Ron Paul fans to Bernie Sanders supporters — to despair.

In the regulatory state, rules and laws are used to shape industries. To both restrict entry, and to burden new entrants. Regulations usurp the traditional role of tort, which punished fraud and negligence while otherwise leaving entrepreneurs to innovate at will. To dedicate their energies, not to complying with bureaucratic diktat, but to serving the customer. To building a better mousetrap that gets millions beating a path to their door.

fig1_cumul_fed_rules

One of the more elegant models of the regulatory process itself is economist Bruce Yandle’s “Bootleggers and Baptists” model. In Yandle’s model, legislation come from a coalition of true believer “Baptists” who unite with self-interested “Bootleggers” to make a coalition for change.

The true believers will always exist for any cause — if you want to outlaw stiletto-heel shoes, or puppy clothes, or open-air Jazz concerts, you’ll always find some crusaders to cheer you on.

The problem is when these ubiquitous crusaders are joined by sufficiently powerful interest groups. The crusaders become the face of the movement, the altruistic reformers just trying to make the world a better place. While the “Bootleggers” help behind the scenes, providing adult supervision and resources. And, ultimately, writing the actual laws if the movement succeeds.

The birth of the regulatory state is the ultimate Bootleggers and Baptists process. The public-interest rationale — the crusade — claimed Big Business was running roughshod over the people. Big Business had to be reined in, went the journalistic chorus. Many of whom, incidentally, were actually paid by those very Big Businesses, either indirectly in advertising payola, or even directly with cash in brown envelopes.

These regulatory Bootleggers were, of course, Big Business itself. After all, who has a greater interest in legislatively regulating industries than those companies themselves. Whatever noble intentions the Progressive reformers had, the Bootleggers have the means, and the incentive, to take over the process. The Baptists are the cannon-fodder, then the Bootleggers write the actual rules.

And rewrite they did. Influential businesses succeeded in converting large swathes of American business into their private corporatist playground. Enforced at gun-point by the regulators, they could dictate industry-wide practices that would have previously been litigated as illegal collusion.

Pages-in-the-federal-register-2014Of course, Big Business did not use this new rule-making power for the public good. They used it to largely convert the American economy from an innovation incubator into a tightly regulated permission-based system with heavy burdens actually intended to handicap startups.

Americans had created precisely what the Progressives had fought so hard against — a class of business lobbies that, armed with legislative power, now truly can run roughshod over the people. Dozens of large corporations, from Boeing to Exxon, and industry lobbying coalitions like Chambers of Commerce, the National Association of Realtors, the Recording Industry Association, or the Cable and Telecommunications Association.

With their new regulatory power, these lobbies became kids in a candy store. They could cheaply buy influence with politicians or regulators, then merrily write the rules that govern themselves. While, of course, denying any representation for the disruptors and innovators who threaten the status quo power. This lack of voice for disruptors was, naturally, by design. After all, what industry leader wants disruptive start-ups coming along and eating their lunch.

And so we get a world where Uber needs to spend millions on lawyers to enter new markets. Where Airbnb or financial startups must constantly look over their shoulder lest the regulators come and destroy their business, even imprison the founders.

So we shifted from a tort-enforced free innovation environment into a regulation-straitjacketed den of thieves that actually tries to punish innovation, while sharing legislative favors among incumbent special interests.

Naturally, innovation plunged.

baseball game 1900

To put this monumental shift in perspective, we can sketch out how business worked before the rise of the regulatory state. In the late 19th century many New Yorkers could see the ballgame from their second-floor bedrooms. So, naturally, hundreds of families reinforced their porches and sold tickets for game-day. You’d walk in the house, go upstairs through the bedroom, climb out onto the porch and take a seat. You can even buy beer, hot-dogs and home cooking downstairs in the kitchen.

It’s a world where innovators look for opportunities to serve customers, then they just do it. And, shockingly, no business regulation is needed. If your bathroom was dirty, people would go to your neighbor’s instead. If your porch collapsed, or you sold tickets and didn’t deliver, you’d be sued into destitution. Tort alone governed your business. Meaning you were restricted only by the common sense that you don’t rip people off, and your product should do what it says, including not hurt the customers. After that, it’s up to you to make a better mousetrap and serve the customer.

Now, it’s easy to see in this world why an Edison or Tesla, Rockefeller or Wright Brothers could innovate so massively. It was a world where you see an opportunity you chase it. Tort stops the evil, and after that your one job is serve the customer. It’s a beautiful system, absolutely optimized to maximize innovation and economic progress.

So what’s the solution? As formidable as the problem seems, it’s actually a relief that regulation is our main handicap. Because it means we’re not concerned about human nature or lazy entrepreneurs — it’s cosmetic damage, not a structural defect in humanity. The people themselves will innovate, as they always do throughout history, once they’re freed from the permissions and regulatory burdens on innovators.

image-02-largeHow to manage this? First, I’d argue the most important prescription is a simple recognition of the costs of regulation. To argue for a kind of economic Hippocratic Oath: First, Do No Harm.

In particular, to recognize that we as a society are very poor predictors of innovation. To keep in mind IBM founder Watson’s famous “there is a world market for maybe five computers,” or the 1876 British regulator who asserted that phones have no future because Britain has plenty of messenger boys.

Our inability to predict the future means we are also very bad at predicting how regulations will choke off growth. Meaning every new regulation, however low-burden today, could be an enormous barrier to innovation without our even realizing. So, rather than saying “it’d be nice if industry x did action y” and then writing that into law, the idea is to be quite careful about putting up chains across roads when we have no idea who will be using them.

Second, concrete efforts to scale back regulations. Sunset provisions, for example, where regulations automatically expire unless renewed. Some countries, like Canada, have even experimented with “regulation-hunting” agencies that look for burdensome regulations that have outlived their usefulness.

Third, we need a greater appreciation of, and efforts to streamline, the regulatory function of common law tort. Tort should be easy and fast, unburdened by its own restrictive regulations, so that it can pick up the burden that is today inefficiently carried by regulation. Tort, fundamentally, is the perfect regulator — an incredibly agile tool that punishes the evil and leaves the rest of us in peace. Tort lets innovators chase, not bureaucratic diktat, but good-faith efforts to serve the customer.

In the final analysis, we want to keep our imagination alive to what Frederic Bastiat called the economic “unseen” — the possibilities that could have been, and that still can be. The millions of lives we continue to lose every year from slower medical innovation. The billions who remain in poverty or environmental harm because innovation has slowed or stopped. Considering we have a neglected tool sitting on our shelf in the form of the tort system itself, the enormous — even fatal — costs of the regulatory state deserve to be both exposed and reformed.