Regulating Innovation

I was honored last week to attend the Fourth Annual Law & Entrepreneurship Retreat, hosted by Gordon Smith at the BYU Law School. It was a wonderful collection of legal scholars who focus aspects of their teaching and scholarship on legal issues affecting entrepreneurs and innovation. Several of the papers and much of the general discussion considered innovation, particularly whether we can or should attempt to regulate innovation and related risks. The economic crisis provided the general context for this discussion; should we restrict or monitor innovation in the financial industry and, if so, how can we perform those tasks effectively?

I was struck by several things during the conference, including the universal and recurring nature of the innovation conundrum. I realized as we were debating solutions to abuses of credit derivatives that the proposed subject of regulation was novel, but the problem was not. We struggled with governing “the marriage of steam power and iron rail” in the late 1800s (see sample of related text here); it is a habitual problem in the biotech, energy, intellectual property and other fields (see here, here and here); and the problem is not confined to the United States (see here).

The recurring Hobson’s choice lies in the nature of innovation itself—to innovate is to create something new or different. As one commentator observes, “Genuine novelty knows no rules. We cannot reduce to routine what we do not know. Yet of course we cannot resist trying.” (See here at 1.) And innovation is often a very good thing (see here). So the challenge is to mitigate the negative side effects of innovation without stifling it altogether. (For a discussion of the regulation choices and challenges in the financial product context, see here, here and here.) Certainly easier said than done.

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6 Responses

  1. Innovation or invention regulated by a free market is ALWAYS a good thing. This does not mean that we will not have bubbles or other mistakes. Innovation will definitely lead to both of these things – innovation includes the ability to fail. Whether countries, companies, or people prosper depends how they react to these inevitable failures associated with innovation. The experience of England and France with the South Sea company and the Mississippi company are instructive. A major reason why England became a world empire in the 19th century instead of France is how they reacted to the financial innovation of the stock market and the crises of the South Sea Company and the Mississippi Company. Unfortunately, the US has seems to have followed the path of France since the late 90s. See http://hallingblog.com/2009/06/17/sarbanes-oxley-–-the-medicine-is-worse-than-the-disease-part-1-background/ and http://hallingblog.com/2009/06/18/sarbanes-oxley-–-the-medicine-is-worse-than-the-disease-part-2/

    Dale B. Halling, Author of the “Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation.” http://www.amazon.com/Decline-Fall-American-Entrepreneur-Regulations/dp/1439261369/ref=sr_1_1?ie=UTF8&s=books&qid=1262124667&sr=8-1

  2. When I read of a “recurring Hobson’s choice”, I’m guessing it’s that if we want innovation, then it has to unregulated…I agree with that but wonder if that is what you meant.

  3. Michelle Harner says:

    Dale: Thank you for the comment and the related links. I generally agree that markets can be an effective means to regulate and facilitate innovation. I also agree that, as with any business venture, the risk of failure is part of innovating and doing business. I am not, however, comfortable relying solely on the markets; we know they are imperfect and that information asymmetry exists. Accordingly, I think we need some regulation to supplement the markets, particularly on issues of disclosure. Best regards, Michelle.

  4. Michelle Harner says:

    Maryland Conservatarian:

    Thank you for the comment. I actually debated about using that term because I do believe some regulation is necessary in this context. And I also believe that the regulation could be structured so as not to stifle innovation. Nevertheless, I ultimately chose to use the term “Hobson’s choice” because I think that is what we face. Whether it is political pressure or the reactive nature of this type of regulation, I suspect that any regulation would be somewhat paternalistic and tend to suppress innovation. Thus, explaining the innovation/regulation problem as a “take it or leave it” proposition seemed appropriate to me.

    Best regards, Michelle.

  5. A.J. Sutter says:

    The word “innovation” has been endowed with such positive connotations in the rhetoric of capitalism that talking about regulating it may give some people the creeps, or even seem to be a profanation. If one replaced the word with the phrase “commercialization of inventions,” it might be easier to think clearly about it.

    There’s something to be said for being slow to adopt “innovations.” For one thing, we often should think a bit more about the consequences before we rush in, as illustrated by Danielle’s recent post about Google Buzz. For another, they tend to have much more longevity than we think: our world is still shaped to a substantial degree by radio, cars, powered flight, telephony, and X-rays — all developed over 100 years ago. (Binary code dates back to Leibniz in the 17th Century.) And bicycles are still the best-selling vehicles in the world, even in the USA.

    An important part of our re-think should be to re-evaluate the precautionary principle. This also involves a re-think of cost-benefit analysis, especially to recognize that its American implementation is far from “objective,” and never was intended to be close (See Theodore Porter’s Trust in Numbers (Princeton 1996)). Our current bias with CBA is to allow innovation unless you can prove that the costs outweigh the benefits; perhaps the burden of proof should be reversed more often. See also various works by Donald Kraybill on how the Amish adopt new technologies into their culture.

  6. Michelle Harner says:

    A.J.:

    Thank you for this very thoughtful and informative comment. I think you raise several great points. I also would note the need to view most innovations as constantly evolving. For example, many of the credit derivative products that contributed to the most recent economic crisis actually protected many of the major financial institutions from significant losses during the tech bubble in the early 2000s. Thoughtful implementation and use of innovations should continue even after the adoption or acceptance of the product.

    Best regards, Michelle.