Regulating on the Technological Margin

June 8, 2017



At their onset, and sometimes well beyond that, radical technological breakthroughs can present difficult public policy dilemmas. Splitting the atom was, and is, one example. Artificial intelligence, now trading in our financial markets and beginning to show up in our automobiles, may turn out to be another. Recombinant DNA first provoked consternation in the 1970s, and 21st century developments in synthetic biology are raising new questions about how we should govern what we do not yet understand.

The evolving pace of technological advancement

Emerging technologies are, by definition, full of surprises: there are developments that we cannot fully anticipate, and may include some bad outcomes as well as good ones.  This presents a challenge for anyone trying to make forward-looking policy decisions. In a sense, though, emerging technologies are nothing new. Since the industrial – and political and economic and legal – revolutions of around 1800, the pace of innovation has been unrelenting. This has sometimes been disruptive, and has generated some backlash – like the 19th century Luddite movement in Great Britain.

Overall, technological advances in the past few of centuries have been so beneficial to human health and welfare that economists have dubbed it the Great Enrichment, and have struggled to explain its astonishing magnitude. Economist Robert Gordon, in The Rise and Fall of American Growth, has argued that it cannot continue: that we have reached the point of diminishing returns to innovation itself, as “all the good stuff” (like indoor plumbing) surely has already been invented. On the other hand, it may be that Gordon, like most of us, simply lacks the imagination to foresee what wonders might be accomplished by future advances in artificial intelligence, or synthetic biology, or space travel.

Those who innovate present a difficult problem for those who regulate – and vice versa

Whether it is using benefit-cost analysis or some other set of criteria for making decisions, a regulatory agency will have difficulty anticipating how things might change in the future. Any rigid set of rules will become obsolete as technology changes, and will require constant revision lest they become an obstacle to innovation. Indeed, that inability to adapt is sometimes an argument for deregulating altogether. As the late Cornell economist Alfred Kahn, then Chairman of the Civil Aeronautics Board, was removing price controls from the airline industry, he was asked how airlines might evolve after deregulation. His answer: “If I knew what was the most efficient and rational arrangement, I could just order it!” His experience with the pathologies of economic regulation persuaded him that a deregulated airline industry would perform better than a regulated one, even if he did not know exactly how it would do so – indeed, because he did not know exactly how it would do so. Such humility is an important and rare virtue in a regulator.

Regulatory barriers to entry

In the case of health and safety regulation, we often adopt another means of avoiding rigid rules, by requiring the proponents of new technologies to seek permission from a regulatory agency before coming to market. The law can prohibit the marketing of any new drug, for example, until the manufacturer has demonstrated that it is safe and effective. This avoids the need to write rules in ignorance of future developments, but still enables the Food and Drug Administration to evaluate the efficacy (~benefits) and safety (~costs) before approving the new drug for sale.

The problem is that this prior-approval requirement itself creates a barrier to innovation, and one that innovators may not be able to overcome. This problem is made much worse because prior approval also becomes a barrier to competition and thus enhances the market power of incumbent suppliers. The incumbents are likely to be much more organized than the innovators, and will have an established relationship with the regulators and with their oversight committees in Congress. The result is that a regulatory program that was intended to protect health, safety, or the environment, can become captured by special interests and instead transform into an anticompetitive and anti-consumer weapon. This is at least one part of the explanation for shockingly high prices for some drugs. The drug approval process that was intended to be beneficial for consumers has prevented or delayed some new products, and thereby has subjected consumers to monopoly pricing for the limited number of drugs that have been approved for certain uses.

Mother, may I?

In a recent book, The Permission Society, Timothy Sandefur argues that this tendency to require prior governmental permission is antithetical to the fundamental tenets of a competitive marketplace and of a free society. He points to the challenges faced by innovative companies like Uber and Lyft, or AirBnB, who draw the wrath of incumbents (traditional taxis and hotels) and of the regulators who serve them. It may well be the case that having to ask permission to innovate is worse than having to live with an obsolete set of rules. Rules at least provide certainty and perhaps can be adapted or worked around. The requirement to secure permission can present a politically insurmountable obstacle.

While the debate about the effects of requiring permission to innovate has been much in the news lately, it actually goes back decades. In 1981 an influential study called Clean Coal/Dirty Air described how high-sulfur coal producers were able to shape environmental standards in order to exclude newer sources of cleaner low-sulfur coal. Brookings economist Bob Crandall coined the term “New Source Bias” to describe the general tendency of environmental regulation to grandfather the incumbent firms in an industry, while new firms are forced to meet strict new pollution standards. There is, of course, a sensible explanation for why a regulator might want to draw that distinction: it can be far cheaper to install pollution control technology on a newly built plant than it is to retrofit an older plant. Similarly, when the requirements for approval of new drugs or new pesticides are made stricter, it makes sense to grandfather the existing products, at least for a while. But once the incumbents become grandfathered, they enjoy a competitive advantage in the marketplace. Their efforts to influence regulatory policy will thereafter be directed at preserving their advantage and making things difficult for any would-be new entrants.

Yandle: Bootleggers and Baptists

Drawing on observations about state and local regulation of alcohol, Clemson economist Bruce Yandle pointed out that most regulation is sustained by “Bootlegger & Baptist” coalitions.

Durable social regulation evolves when it is demanded by both of two distinctly different groups. “Baptists” point to the moral high ground and give vital and vocal endorsement of laudable public benefits promised by a desired regulation.  Baptists flourish when their moral message forms a visible foundation for political action. “Bootleggers” are much less visible but no less vital.  Bootleggers, who expect to profit from the very regulatory restrictions desired by Baptists, grease the political machinery with some of their expected proceeds.  They are simply in it for the money.

The “grandfathering” phenomenon is a special (and very common) case of Yandle’s Bootlegger and Baptist theory: Once my own drug is approved for marketing, I will encourage the regulatory agency to be very strict about approving any generic versions or close substitutes.  The public policy argument will be that this strict scrutiny is necessary to protect consumers; the unspoken motivation, however, is that I can profit by depriving consumers of any alternatives.

Huber: “Exorcists” and “Gatekeepers”

Peter Huber, in 1983, introduced the terms “Exorcists” and “Gatekeepers” to describe these two general types of health and safety regulation: the former searches for unacceptable risks and takes action to mitigate or extinguish them; the latter stands guard at the entrance to the commercial marketplace and opens the door only to those new products that appear beneficial from the regulator’s perspective. Huber pointed out the different incentives faced by the regulators. Exorcists are constantly trying to do battle with established interests, whereas gatekeepers only contend with weaker new entrants, and have the support of the established interests. Indeed, a gatekeeping agency might be able to charge a fee for the “service” of reviewing new products (as FDA does); something the exorcists could never get away with.  Moreover, the regulated industry may lobby to cut the budget of an exorcist; whereas the industry is more likely to lobby on behalf of the gatekeeper, to ensure that it has adequate funds.  The ability to withhold permission is in many respects a far greater power than the power to write rules, and gatekeeper agencies can be far more costly than exorcists – even if the costs tend to be less easily observed opportunity costs.

Unpredictable Futures

In The Future and Its Enemies, (1998) Virginia Postrel argued that human betterment depends upon a messy, dynamic, and inherently unpredictable process of innovation. Those who try to plan progress, and to control this evolutionary process, are the true enemies of humanity’s future.

In a 2014 book Adam Thierer presented a general argument for favoring Permissionless Innovation. He contrasts this with the often invoked “precautionary principle.”

Experimentation with new technologies and business models should generally be permitted by default.  Unless a compelling case can be made that a new invention will bring serious harm to society, innovation should be allowed to continue unabated, and problems, if they develop at all, can be addressed later.  In contrast, the Precautionary Principle is the belief that innovations should be curtailed or disallowed until their developers can demonstrate that they will not cause any harms to individuals, groups, specific entities, cultural norms, or various existing laws, norms, or traditions.

Thierer acknowledges exceptions, and concedes that the case for precaution is strongest when “the potential for clear, catastrophic, immediate, and irreversible harm exists,” or where innovation raises “profound, morally weighty issues.” 

We need to be alert to such exceptions, but must not forget that our main task is to keep the exceptions from swallowing the rule: innovation, and its spectacular benefits, is the disruptive product of freedom, rather than of central planning or of any system that requires prior approval.

This commentary is excerpted from a draft report for the Hastings Center, in Garrison, NY.