Taking innovation seriously

Matt Ridley made an interesting proposal in his Times column last week. In the piece he discussed the idea of the Her Majesty's Government adopting the innovation principle, which he summarises as "examine every policy, plan or political strategy for the impact it could have on innovation, and if you find evidence that the policy is going to impede it, then drop, change or rethink the thing."

He suggested that the Conservatives ought to "pledge to set up an innovation commission, guided by the innovation principle, whose job is to examine policies and report on their likely impact on innovation?" The Adam Smith Institute typically recoils at the thought of creating yet another quango, but I think it's worth making an exception in this case. If there's one thing in need of more regulation the regulators themselves.

But what would actually change if politicians and regulators were forced to take innovation seriously? Ridley suggests we'd have cheaper, safer food thanks to genetically modified crops and fewer people would smoke as burdensome EU rules on vaping would never get past the innovation commission.

I think there are two other areas where taking innovation seriously would lead to fundamental regulatory changes.

1. The Gig Economy

Innovative start-ups like Uber, TaskRabbit and Deliveroo are creating an on-demand economy that enriches consumers and offers new flexible models of working. Take Uber drivers for example: they're overwhelmingly happy to trade off traditional employment rights for the ability to work when and how long they want. Yet recently an employment tribunal ruled that Uber drivers should be classified as workers and that Uber be forced to pay the minimum wage and offer sick pay. This not only disrupts Uber's entire business model, it's having a chilling effect on other gig economy start-ups who are in a sort of legal limbo.

If regulators and courts were forced to subscribe to a form of the innovation principle, then legally ambiguous innovative workplace arrangements would be be given the benefit of the doubt.

This is because there's an asymmetry between over and under regulation. In medicine, we tend to be more concerned with false negatives than false positives. Better to be over-cautious and provide unnecessary treatment than let a condition get worse. The reverse is true when it comes to regulation. Market forces tend to mitigate the effects of bad behaviour. A monopolist can only keep prices so high before inviting competition, an exploiter can only keep wages so low before they lose workers to other employment opportunities. The costs of failing to crack down on bad behaviour are static and limited.

That's not the case with false positives. Wrongly cracking down on Uber or Deliveroo doesn't simply harm Uber and Deliveroo's shareholders and customers, it also hurts consumers widely by deterring innovators from entering the market providing similar services. Consumers are not just missing out on Uber and Deliveroo but missing out on their unborn competitors. The costs of shooting first and asking questions later are dynamic and unlimited.

2. 'Tech monopolies'

If Theresa May keeps her word, Britain is set to leave the jurisdiction of the European Court of Justice. The ECJ has typically taken an over-active approach to enforcing competition, often confusing market share with market power. If Britain were to take innovation seriously we ought to take an error-cost approach to enforcing competition law.

Judge Easterbrook set out the error-cost approach in his paper 'The Limits of Antitrust'. He shared the insight that false positives were much more harmful than false negatives. Wrongly penalising pro-competitive behaviour is more harmful than failing to act against anti-competitive behaviour. Market forces tend to correct against the latter creating incentives for new entrants to disrupt monopolists.

He observed that errors of both kinds were frequent because distinguishing between pro-competitive and anti-competitive behaviour is intrinsically difficult. It's especially difficult when dealing with new products and business models. Firms often don't fully grasp the full competitive effects of their business practices in advance, rather they employ a trial and error process.

Take Google for example. In 2016 the EU made an (in my view baseless) antitrust complaint against Google relating to its android operating system. But, Google is an excellent example of a firm experimenting with different business models without a clear understanding of their effects on competition. AdSense is responsible for nearly one fifth of Google's total revenue but was famously produced during Google's '20 percent time' where employees are given free range to work on projects of their own choosing. If firms themselves often fail to understand the full implications of product innovation until much later on. How can we expect courts to understand the full competitive effects of innovative business practices?

That's especially the case when dealing with companies like Google where they produce multiple complementary products. Antitrust law expert Geoff Manne highlights the problem with the EU's complaint about Google preinstalling Android apps:

Of course, Google receives some benefit from pre-installing its apps: Doing so provides a chance for the company to realize some return on its massive investments in the Android ecosystem by promoting its own products. Although Google requires many Android device makers to pre-install Google Search and to set it as the default (but not exclusive) search provider on their phones, this is hardly a bad thing: Search helps finance the development of Google’s other (free) apps, as well as (free and open-source) Android itself.

Imagine what might happen if Google were prevented from requiring device makers to pre-install Google Search or the Chrome browser—the apps from which it actually earns substantial revenue—as a condition of pre-installing its other apps on Android devices. Google would likely then charge hardware makers licensing fees to pre-install apps like Gmail and YouTube, the cost of which would be passed along to consumers in the form of higher device prices. This would hardly be a net gain for consumers, given that they already enjoy unrestricted app choice at lower cost today.

Alternatively, Google could vertically integrate like Apple, exercising tighter control over the Android ecosystem. This would be no boon for competing app developers, who are attracted to Android’s openness—just ask Spotify what it thinks of Apple.

A hypothetical innovation commission ought to force regulators to give businesses in markets with high levels of innovation the leeway to experiment with new business models. One way to do that would be to require direct proof of an anticompetitive effect and not merely rely on theoretical harms. Another would be to grant legality per se to new product introductions to remove regulatory uncertainty for innovators.

Innovation massively matters, but often regulations can have chilling effects and deter welfare-enhancing changes. An innovation commission could tip the scales in favour of innovation and prevent employment courts and competition regulators from keeping new products from the market.