Global attitudes to disruption merit some searching questions

The announcement last week that the Nobel prize for economics was going to Toulouse professor Jean Tirole led to a flurry of essays and articles discussing the economic effects of regulation, the area of research in which Tirole has forged his reputation.

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, to use the formal, delightfully unwieldy title, is rarely as timely as this year's. The Royal Swedish Academy, in explaining Tirole's prizeworthiness, pointed specifically to his work on industrial organisation and competition policy, which is particularly relevant to the thorny issues raised by regulation of technology companies.

Understandably, when we try to identify the factors that contribute to a vibrant innovation ecosystem, we tend to focus on the visionary founders, the cultural attitudes to entrepreneurship, the importance of network effects, the role of venture capitalists and so on.

But Tirole’s work, often applying game theory in the examination of everything from platform competition to the risk of regulatory capture to the economics of patent markets, highlights an underappreciated ingredient required for encouraging innovation – the larger impact of regulation.

Given the myriad problems regulators are having in grappling with entirely new challenges posed by the technology industry, from Google’s search market dominance to Apple’s ebook strategy to Amazon’s dominant online retail position, it’s vital to thoroughly understand how various forms of regulation can affect and curb innovation.

It is Tirole who has provided exactly that theoretical framework, in particular his theories on platform competition in two-sided markets, which are relevant when we consider how to regulate things like net neutrality or online advertising.

Wide-ranging talk

Coincidentally, a few days before the Tirole announcement, I attended a wide-ranging talk by

John Gapper

, chief business commentator of the Financial Times, on “Regulating innovation in the new Europe”.

In the course of the talk, Gapper discussed the varying approaches to regulation in the US and Europe, and the philosophical differences those approaches represent. Silicon Valley doesn’t just benefit from Stanford’s production line of smart workers and access to capital, but also from a regulatory framework that tends to be more permissive of new technologies than that in Europe. Key to this, he pointed out, was the differing attitudes to disruption.

"The favourite word in Silicon Valley these days is disruption, which is a rather nice word that suggests you're shaking things up in a positive sort of way," Gapper said. "But what it actually means is destruction of existing businesses. Joseph Schumpeter, the Austrian economist, expressed it very well in his phrase 'creative destruction', and the nature capitalism being a constant ferment of things being pulled down, and rising and collapsing. In a broad sense, the US is far more comfortable with creative destruction than Europe."

Now, the notion that the US is a regulation-free environment is plainly wrong – in the annals of hilariously bad regulations, the US boasts some of the most blatantly protectionist measures imaginable, usually parading under the flimsy guise of consumer protection.

Gapper acknowledged as much, and also pointed out that the EU has some of the smartest regulatory policies – the regulation of telecommunications in the EU is one example where Europe is far ahead of the US, for instance, largely because European governments adhered to Tirole’s theories when breaking up state telecom monopolies.

But, on the whole, many European countries use regulation to protect older businesses from disruption, as evidenced in the European Commission's antitrust case against Google or Germany's attempts to undermine Uber.

‘Vital infrastructure’

A related point was made in a

New York Times

opinion piece by German journalist Anna Sauerbrey. “In Berlin, Sigmar Gabriel, the vice-chancellor and economics minister, is investigating whether Germany can classify Google as a vital part of the country’s infrastructure, and thus make it subject to heavy state regulation,” she wrote. “To create and grow an enterprise like

Amazon

or Uber takes a certain libertarian cowboy mind-set that ignores obstacles and rules... When problems appear, we look to Vater Staat – the Father State - to protect us.That includes challenges by ‘disruptive’ business models, like those coming out of Silicon Valley.”

Sauerbrey is articulating more than just German resistance to disruption – it’s a common sentiment across Europe. The impulse to protect the status quo is strong, and in many cases that mitigates against the growth of disruptive companies – the fact there are so few consumer-oriented technology companies in Europe is rather telling in that light.

But it struck me that Gapper somewhat ignored a critical aspect of the technology industry’s disruptive capacity that requires extremely cautious regulation. Schumpeter’s creative destruction usually refers to the erosion of existing businesses and the fall of market incumbents, but the innovation coming out of Silicon Valley is disrupting more than just commercial enterprises – it is fundamentally eroding our sense of privacy, and with it a whole host of social norms.

Given that sort of disruption, the European impulse to maintain the status quo via regulation is much more prudent than the more laissez-faire approach in the US. After all, once destroyed, that expectation of privacy can never be restored. From Facebook to iCloud, from Google advertising to GPS-equipped smartphones, we are in uncharted territory for regulators. I suspect we're going to be increasingly looking to Jean Tirole and his colleagues as we try to strike the optimal balance.