Symposium | Regulating the Digital Economy

Managing the Big Bang: The Regulator’s Dilemma

By Larry Downes

Tagged Regulationtelecommunications

My new book, Big Bang Disruption: Strategy in the Age of Devastating Innovation, is not a policy book. But its findings about the changing nature of innovation are the best proof I have found of the need for a radical shift at all levels of government, from laws and policies that delay and deflect disruptive change to an agenda that maximizes the profound potential of technological inventions to improve the human condition.

That agenda is largely absent from the platforms of Republicans and Democrats. Though both parties wrap themselves in the rhetoric of innovation, entrepreneurship, and technology, they pursue that agenda with waning enthusiasm as competing interests present themselves. And competing interests present themselves with increasing speed and urgency, thanks to the accelerating pace of technological transformation and the corresponding stress it places on incumbent industries.

The innovations that are changing the nature of daily life are largely built with digital building blocks such as computer processors, data storage, and broadband communications. In the famous formulation known as Moore’s Law, these are technologies whose capacities double every 12 to 24 months, even as their unit price declines. (They also get smaller, and use less power.)

In Big Bang Disruption, my co-author Paul Nunes and I describe the new model for disruptive innovation that has emerged in response to 50 years of Moore’s Law of exponentially better and cheaper computing. As the Internet ecosystem matures, entrepreneurs can now experiment at little cost or risk with new combinations of off-the-shelf hardware and software components, collaborating on design, funding, and testing directly in the market with real consumers.

The digital revolution fueled by Moore’s Law—whether in the form of cloud computing, ubiquitous mobile broadband networks, or large-scale databases and sophisticated analytic techniques (so-called “big data”)—has generated its own impressive roster of “big bang” disruptors. Now its applications and techniques are accelerating the creation of exponential technologies in other fields. We have “open-source” science, for example, and component-based manufacturing. Beyond computing, there are nascent exponential technologies appearing in fields as varied as optics, materials, energy, and genetics, among others.

Moore’s Law has changed not just the when, but also the how, of technology-fueled industry transformation. Clayton Christensen’s classic formulation of a “disruptive innovation” described it as a cheaper product or service that began as inferior in quality but that eventually surpassed its older competitors. The first “personal” computers were no threat to mainframes, for example, but after a decade of rapid improvement, they ushered in the client-server and cloud revolutions. Mainframes—and businesses built on their sale and operation—became dinosaurs, at first gradually and then suddenly.

By contrast, “big bang” disruptors start out better and cheaper. Think of free smartphone navigation apps, peer-to-peer review sites, and ride-sharing and dispatching services like Lyft and Uber. The digital camera in your tablet is better and cheaper than all but the best film-based cameras. And next year’s will be better still. For these disruptors, there’s no need to educate the market, or for pioneering “early adopters” to work out the bugs and fund mainstream development. They achieve what we call “catastrophic success,” catalyzing abandonment of older products across most market segments.

The digital revolution has already engulfed the industries closest to it—computing, communications, consumer electronics, entertainment, and media—in a permanent firestorm of what Joseph Schumpeter first called “creative destruction.”

But as processing, storage, and broadband capacity continue their ascent into the stratosphere of faster, cheaper, and smaller, every industry is now transforming at the speed of Moore’s Law, including some of the most mature and most regulated. Health care is being deconstructed by the proliferation of low-cost sensors and the decoding of the human genome; manufacturing is being redefined by advanced robotics and 3-D printing; energy stands poised for a rebirth as the scarcity of fossil fuels sparks innovation in a variety of more sustainable alternatives. Agriculture, education, professional services, and retail are likewise transforming.

The pace of that change has put profound pressure on incumbent enterprises. And as that pressure builds, they in turn are pressing lawmakers to help them slow the pace of transformation to something traditional management practices can handle. But even as industries call for a time out, consumers are charging full speed ahead. Increasingly, the new economy is the economy.

With that shift, the traditional subjects of regulation, and traditional sources of taxes, fees, and other revenue to fund it, are shrinking. Government, like any business, needs to find its place in the new ecosystem. So even without the urging of vested economic interests, policy-makers are eager to find their own new “markets” on the Internet.

Innovation policy has reached a critical juncture. The acceleration of disruptive innovations and the dramatic new ways in which breakthrough products and services enter and exit markets are driving deep divisions between, on the one hand, the industrial law of the last century and the regulatory machinery created to enforce it and, on the other hand, the digital economy that now drives economic growth and competitive advantage.

It’s no surprise, then, that collisions at the accident-prone intersection of technology and policy continue to pile up, generating more collateral damage all the time. The failure of policy-makers to adopt and adhere to a truly pro-innovation agenda explains such disparate problems as Congress’s inability to pass legislation curbing patent trolls, irrational immigration policies for high-tech workers, and counterproductive tax laws that discourage repatriation of foreign earnings.

It also explains the counterintuitive political and industry coalitions that emerged in the bruising 2011 war between content producers and their customers over proposed new Internet copyright laws known as SOPA (Stop Online Piracy Act) and PIPA (Protect IP Act), and the renewed and highly misleading fight over so-called “net neutrality” rules.

In short, the failure of policy-makers to stand up for the disruptors has created a vacuum, now being filled by a new kind of Internet-enabled lobbying. First organically and now artificially, pro-technology consumers are being organized to advocate on behalf of startups challenged by legal restrictions and the incumbents who would rather outlaw them than compete. These startups include, at the local level, Uber (transportation), Airbnb (hospitality), and Aereo (broadcast television). At the federal level, we have Bitcoin (finance), private drone aircraft (transportation), and the genetic testing service 23andMe (health).

Already, each of these innovations has faced serious regulatory setbacks, with Aereo searching for a new business model in the wake of a Supreme Court case that rejected its core design, 23andMe severely restricted by the Food and Drug Administration, and the rest fighting wars on multiple fronts simply to operate.

Customer advocacy can be empowering, but it can also quickly become counterproductive. Mobs can be misdirected. And once they’ve stormed the castle, they might start looking for other, less obviously evil, targets.

Worse, Internet users are even more vulnerable to capture than are regulators. Having witnessed the profound efficiency of tapping into a network of billions of users, every petty dictator is now keen to co-opt them for his own private war.

That’s the lesson of the strange and wildly disproportionate outbreak of hostility toward the Federal Communications Commission’s latest “net neutrality” proposal. Well before the proposed new rules were made public, FCC Chairman Tom Wheeler and his fellow Democratic commissioners were blindsided by a very personal campaign, waged mainly by their supposed public-interest allies.

Proxies supported by content companies, notably Netflix, immediately began claiming that the coming rules would not, as with two previous efforts rejected by the courts, define limits on how Internet service providers (ISPs) can manage complex and fast-changing Internet traffic patterns. Rather, the chairman was secretly planning to “end the Internet as we know it” and “kill net neutrality” by “authorizing” ISPs to offer “fast lanes” to individual companies to get their packets to consumers’ devices ahead of those of their competitors.

The actual rules Wheeler proposed “authorized” nothing. Indeed, they were largely indistinguishable from the agency’s last try, save for a single legally necessary wording change (from prohibiting “unreasonable discrimination” to prohibiting “commercially unreasonable” practices). They may still not pass judicial muster, but if they do, from the standpoint of enforcement, that difference probably amounts to no real difference at all.

Much of the anti-Wheeler rage, it is worth emphasizing, was suspiciously directed at proposed rules that hadn’t even been made public. Those doing the most extreme doomsaying knew full well that whatever Wheeler was pursuing, it wouldn’t “authorize” anything. That didn’t matter. Their goal was not to get rules that were even more interventionist, or any rules at all. It was instead to use the proceedings to restart earlier failed efforts to force the FCC to “reclassify” the Internet as a public utility, if not to nationalize it outright. Internet users were merely the pawns.

So what was, and is, going on here? Proxies for large content providers have appropriated the ideology of the pro-innovation agenda and twisted it to pursue a private fight. They believe (naively, and dangerously so) that any regulatory distraction imposed on infrastructure providers is a source of leverage for them. In this case, they appear willing to risk inserting a slow-moving regulator into a fast-changing ecosystem, in ways that may ultimately backfire by slowing future innovation and unintentionally bringing the regulators down on them in some future scuffle.

The moral of the story here, as in other recent technology policy dustups, is to be extremely skeptical when one set of companies enthusiastically embraces punitive regulations for their rivals, suppliers, or customers (in this case, all three). Though the rhetoric of net neutrality is all about preserving the environment for continued big bang disruption, it’s only rhetoric. Inches below the surface, it’s just another form of rent-seeking.

There’s a better and safer way to protect and encourage disruptive innovation. First and foremost, governments must recognize severe limits in their ability to shape the destination, if not the trajectory, of disruptive technologies. Technology and policy run at different clock speeds, and the gap is getting wider. Even with the best of intentions, the most nimble regulatory agency still can’t keep up with the pace of change in consumer markets. When they try, the result, more often than not, is the invocation of the law of unintended consequences, where rules intended to encourage such noble goals as enhanced competition or the public interest wind up doing just the opposite.

A pro-innovation agenda begins instead by recognizing that markets are far more likely to resolve market failures than regulators, and to do so at a lower cost. This is not because markets are perfect, or appropriate subjects of uncritical reverence, but simply because markets react more quickly than do governments to the negative but usually short-term side effects of disruptive innovation. The next generation of technology is far more likely to remedy consumer harms than regulatory intervention can, and with considerably less economic friction.

When new products and new enterprises rise and fall quickly, in other words, market dominance, anti-competitive behavior, and even predatory pricing are increasingly short-lived problems. Market leaders can’t lock in their positions (or their customers) when a new generation of disruptors is just a few years away. Internet Explorer, Microsoft’s Web browser, once held a bigger share of its market than even the most rapacious railroad trusts of the nineteenth century. Yet it was a combination of startups including Google, along with the emergence of mobile computing, and not the Justice Department’s botched antitrust case, that brought it down.

So a pro-innovation agenda requires lawmakers to restrain themselves from the temptation to act, to shy away from the instinct to do something—anything—to fix what is often just a transient problem. As Federal Trade Commissioner Maureen Ohlhausen puts it, they must embrace “regulatory humility.”

When intervention is unavoidable, the pro-innovation approach looks for remedies and enforcement mechanisms that are flexible and efficient, regulating as narrowly as possible. It generally favors federal over state action, and multi-stakeholder, nongovernmental bodies over federal agencies or, even better, self-regulation by the technologists themselves (as is the case with the Internet’s core protocols and architecture). It favors ex post market correctives over ex ante “prophylactic” rule-making (a favorite term at the FCC). It favors regulations over statutes, and standards over regulations.

It decidedly favors what technology researcher Adam Thierer calls “permissionless innovation” over pre-emptive controls—prevalent in much of the world and in many industries—that require disruptors to secure approval from regulators before they can offer their products to the market. It favors support for university-based basic research (whence the Internet) over subsidies for applied research (sorry, Solyndra). Even better, it advances policies that encourage private experimentation and investment, such as exempting emerging technologies, whenever possible, from restrictions and taxes accreted over long periods of time to resolve long-gone problems generated by earlier innovations.

These preferences, unfortunately, often conflict with the visceral reaction of lawmakers to anything new. The reflexive response, instead, is to press pause and hope the innovation goes away, or morphs into something more familiar. It is not for nothing that science fiction author Arthur C. Clarke famously observed, “Any sufficiently advanced technology is indistinguishable from magic.” And we know how the Salem witch trials, for instance, viewed the appropriate response of law to the possibility of magic.

The instinctive reaction of policy-makers to innovations that move in a single step from science fiction to practical science has been to ban first and figure out appropriate controls later—perhaps much later. Within weeks of scientists announcing the cloning of Dolly the sheep, President Clinton banned federal funding of the technologies used. More recently, Congress ordered the Federal Aviation Administration (FAA) in 2012 to come up with rules for commercial unmanned aircraft (drones), which have great potential to make better and cheaper everything from public safety to agriculture to environmental protection to newsgathering and delivery services. We’re still waiting. Meanwhile, a multibillion-dollar industry is being unnecessarily retarded as the FAA tries to impose a pre-emptive (and legally sketchy) ban on any commercial use of the technology.

A pro-innovation agenda isn’t simply a set of things for policy-makers to avoid doing. Proactively keeping markets as open as possible is also critical. Regulatory backstops and other means of keeping dominant firms (whose dominance, however, is more fleeting all the time) from gaming the system are imperative. So are laws prohibiting practices with demonstrable consumer harms (but not competitor harms), as well as enforcement agencies with the power and will to efficiently and effectively enforce them, on a case-by-case basis, when necessary.

Usually the threat of enforcement will suffice to discipline the market long enough for technology to do the rest. Even in the absence of FCC “net neutrality” rules, for example, anti-competitive and discriminatory practices are already subject to general antitrust principles, enforceable by the Federal Trade Commission (FTC) and Department of Justice. That, according to the FCC’s own findings, has been sufficient to keep Internet service providers in line up until now.

Faced with a new disruptor, a pro-innovation policy agenda asks whether the new product or service is both better and cheaper than the incumbents’ offerings. If so, it would look to see whether laws, regulations, and institutions were encouraging the most economically efficient diffusion of that technology—whether, to use the economists’ term, there were unnecessary transaction costs that could be eliminated by passing new laws or, more likely, disposing of old ones.

A pro-innovation policy agenda seeks to disentangle counterproductive webs of legal inefficiency where possible. Rather than defining the new dynamic, it then leaves it to market forces to create new incarnations of old industries in a largely unregulated space, then helps transition legacy businesses and their few remaining customers to an orderly shutdown. That’s what’s happening now, for example, with analog telephone networks, where the move to Internet-based telephony has left the regulated business uncompetitive, unprofitable, and largely abandoned. Trials are now being developed to move the dwindling number of consumers who haven’t already cut the cord to Internet protocol-based voice services, which could have the happy side effect of closing once and for all what’s left of the digital divide.

But elsewhere, the pro-innovation policy agenda is increasingly being trumped by those with parochial and decidedly regressive tendencies. We see it in efforts by local regulators to protect their clients in the taxicab and limousine businesses and in other industries threatened by the innovations of the so-called “sharing” economy, in which consumers use the Internet to more efficiently leverage expensive assets, including their cars, homes, and even their expertise.

We see it, likewise, in the FTC’s growing unease with device-based technologies, including low-cost sensors and mobile communications being embedded into everyday objects in the so-called Internet of Things—skepticism they couch in the inflammatory language of privacy protection and cybersecurity.

These are worrying trends connected by a common thread: a political vacuum of lawmakers committed to a pro-innovation agenda. Though candidates across the political spectrum are increasingly heard intoning its principles, flirtation is not adoption. A true embrace of a pro-innovation agenda would take political will. But the payoff—economic as well as political—would more than justify the costs and risks.

Americans, especially those under the age of 30, are deeply cynical about the political process. They live in a universe where technology can be counted on to make the world better and more interesting every 12 to 24 months, where life is approached as a series of problems to be solved through clever hacks, where even impractical dreams can be realized in weeks through a successful Kickstarter campaign. Why should they trust policy-makers who don’t live in their world, or share their optimism for its future, and who can’t be counted on to do what it takes to maximize its potential? Even if that just means staying out of the way.

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Larry Downes is the co-author, with Paul Nunes, of Big Bang Disruption: Strategy in the Age of Devastating Innovation and project director at the Georgetown Center for Business and Public Policy. His previous books include The Laws of Disruption and the best-selling Unleashing the Killer App.

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