On the notion that regulation slows innovation

Does regulation slow innovation? By how much? Should we care?

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I recently learned that credit cards existed in the US for 12 years before credit card regulations were enacted1. That struck me as odd.

Credit cards, one of the cornerstones of modern American life were freely used in the wild without any financial regulations enforcing how credit card providers should act? And that was just okay? How could that be? Today, even with all the disclosures, people routinely misunderstand how credit cards fees and rates work. So it must’ve been a fool’s game in the 60s trying to understand this shiny new tool that gave you access to more money than you previously had.

While twelve years might seem long, it’s understandable that it took some time for regulation to follow. Technology regulation tends to come after the technology emerges. The regulators are essentially always playing catchup. When you’re chasing something, your chance of success is heavily dependent of the speed of your target, as anyone who’s played tag knows.

I imagine this “wait and see” mode of regulation worked reasonably well in the past. You can gripe about cases here and there, but in general, new technology dispersed more slowly in the past. The distribution channels of the past were physical and required the movement of actual stuff. The logistics of moving stuff effectively provide an activation energy barrier to distribution. If you’re selling TVs, you need trucks and trains and planes to move your product. That costs money, time, carbon emissions and logistics expertise.

The dawn of the internet shattered yesterday’s old norms. Pokemon Go showed us that you can have millions of users essentially overnight. And in roughly a decade, Twitter went from being a place for silly, harmless conversations and funny memes to a cesspool where disinformation spreads faster than truth.

If there’s one thing we learned in the 2010s, it’s that software-enabled companies mutate from cute ideas to borderless mammoths way faster than we can comprehend.

If you think about it, we’re lucky that the influential tech companies of the past decade created photo-sharing apps and messaging apps. Imagine if they were health tech companies or edtech companies, scaling at the rate they do? Making countless mistakes and promising “to do better”? Imagine the hacks, the privacy violations, the biased algorithms, the compromised business models and the lack of accountability when things fail. Granted, the stakes are high with social media, but health and education take things to another level. Luckily, we dodged some bullets.

Many reasonable people agree that tech companies need to be regulated. The stakes are far too high and the consequences are too real. Tech companies are ad companies, healthcare providers2, online schools and media platforms. They don’t exist in some protective bubble wrap that makes them immune to the wand of the law.

Yet, there is a loud, hesitant group of technophiles that decry regulation. At the very mention of legal checks and balances, they argue:

Regulation will slow innovation. And that’s not good for business or consumers.

I’ve always found this argument to be misleading at worst and incomplete at best. Let’s examine this claim in more detail.

🏎Does regulation slow innovation?
The core idea here is that red tape makes it more difficult for companies to pursue disruptive innovation. This seems plausible. It’s easy to imagine would-be innovators being frustrated by outdated, bureaucratic processes that fail to understand the new technology. Across the world, we’ve seen bans on bitcoin, facial recognition and CRISPR gene-editing on human embryos. Often times, the regulations are governing products and services that didn’t exist when the rules were created.

This study presents a different picture: the authors found that markets with regulation (in this case, labor regulations) “may have less innovation, but when firms do innovate they tend to ‘swing for the fence’ with more radical (and labor saving) breakthroughs”.

This presents a couple questions: is the goal to have more aggregate innovation? What about the intensity? On a scale that measures “disruptive” innovation from 1 to 10, do we want more 6s and 7s, or would we prefer fewer 9s and 10s? Also, how do we contend with the potential harms of the 9s and 10s if we barely understand them? Would we “close our eyes” and accept the potential benefits of more 10s with the added risk of unknown consequences?

Our answers to these questions will inform how we ought to think about regulation and its influence on innovation on a macro level.

🙅🏽Is it an important effect?
If you’re driving down a road in a Ferrari, the air will slow you down. Forgive me for bringing you to back to middle school physics, but the air resistance acts as a retarding force against the ferocious Ferrari. Aerodynamic drag scales with velocity squared, so as the car speeds up, the effect becomes much bigger.

This slowing effect can be significant depending on your circumstances. If you’re Sebastian Vettel, drag can be the reason between glory and defeat. If you’re on a tight petrol budget, higher drag means it takes more energy to move the car forward so you need to buy more fuel.

Consider another case: you put a single ice block in a preheated oven. As you expect, the oven will melt the ice block and the laws of thermodynamics will nod in agreement. Basically, despite the “best efforts” of the ice block to cool the surroundings, the effect is negligible at best. In fact, it’s the reverse, instead of the oven being cooled, the ice blocked is melted.

When we’re talking about regulation “slowing” innovation, we need to talk in terms of effect size. Is it drag on a sports car or is it the lonely ice block in a hot oven?

Assuming regulation slows innovation, the pertinent question is “by how much?”. And it’s worth evaluating how big that effect is in comparison to other things that slow innovation. For example, if corporate R&D budgets decline by 20%, how much would that reduce innovation? What if the federal R&D budgets or immigration policies drastically change? Which of these is playing a significant role?

We need to look at the effects of regulation on a case by case basis, because they don’t set out to achieve the same thing and they have different scopes of impact.

🏅What might we get if we slow innovation?
This is the part that is often missed in the conversation. What is the return on regulation to society?

Enter seatbelts.

There was a time when seatbelts did not exist. Car crashes were more likely to be fatal and a lot of accidents killed people. Then, federal laws mandated all new cars must be fitted with seat belts. And it has saved lots of lives. Without government regulation, it’s not clear whether car manufacturers would’ve enforced them - there was debate about the efficacy of seatbelts. Till today, people argue that seatbelts prevent individual freedoms (they would like to be free to risk their lives if they are adults). But the overwhelming evidence suggests that this regulation has saved a lot of lives. That’s the outcome worth emphasizing. There is a clear, obvious and unmistakeable measurable societal benefit.

So what if innovation slows? Who decided that unrestrained innovation was ever the goal? Why is innovation pace more important than everything else?

Rather, shouldn’t we pursue innovation at the pace at which it generates the most societal benefit? If that happens to be a tad slower, so be it. We have speed bumps for a reason.

🧏🏽‍♂️“I don’t trust regulators because they are slow/inefficient/ineffective”

We live in a time when it’s popular and easy to criticize the government. Armchair pundits sit at home and pontificate about how they can fix all the country’s problems if given the chance. Pompous VCs tend to be particularly bad at this. They lament the incompetence of government while benefitting tremendously from the same government.

Whenever I hear this, I think of all the things that are possible because of American regulators. Because of regulation, I deposit money in my bank and I expect to have that money even if the bank goes bust. That’s a miracle. That doesn’t exist everywhere on this planet. Because of regulation, I feel safe flying on American planes. Sure, the 737Max debacle was a disaster, but I’m sure that aviation safety would decline even further without the FAA. Because of regulation, chemical plants can’t dump toxic waste into rivers, manufacturing plants can’t ignore safety requirements and untested drugs can’t be released into the public.

Of course, regulation is not perfect. The Gamestop saga on Robinhood made it painfully obvious that financial systems need to be tightened up - how can a stock be shorted 140%? What does it even mean to have shorted more stock than exists?

The solution to imperfectly regulated systems is to design better regulations.

🤑Could it be good for business?
I’m not convinced that content moderation can ever really work for social media companies at scale. The ecosystem is too polarized, and there are no silver bullet solutions that I’ve seen work well.

Given the choice, I bet the leaders of these companies would rather not spend lots of time and resources deciding what content is permitted on their sites. Doing so has limited upside but unlimited downside. Regardless of which point they choose on the curve, it will be considered too little or too much by large swathes of people.

From the companies’ perspective, wouldn’t it be easier if there was some body that dictated what’s permitted and not? This way, companies can focus on abiding by the rules and building products. Exxon doesn’t get to decide how much oil they can dump in the ocean (the EPA does). I’m not arguing for companies to abdicate their responsibility, rather I think the issue is too important to let companies pursue random solutions. Their responsibility should be to adhere to regulators. That said, content moderation is a separate beast of a topic that requires its own essay.

🚒Tomorrow’s regulators

I’ve argued previously that software-enabled companies need to be audited from a technical perspective. Those of us in tech should embrace regulation - it’s not a punishment rather it’s an acknowledgment that we’re working on important stuff. If you’re working on something that could harm society, why wouldn’t you want something that could caution you?

Whoever is out there designing future tech regulations, please make them specific, genuinely useful, non-political and enforceable. The safety of the consumer is more important than anyone’s ego.

✨Talk to Tobi

What do you think about regulation and innovation? Drop me a line in the comments, reply to this email or mail me hi@tobiwrites.com.

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The first “diner credit card” was created in 1950 . But the American Express Card was created in 1958 and the Fair Credit Reporting Act was enacted in 1970