Blue Sky Meetings
February 5th, 2018 (Monday) at 12:10 PM
- Associate Professor, Allard School of Law, University of British Columbia
Location: Jerome Greene Hall, room 646
Topic: Sedimentary Innovation: Responding to Incremental Change
Precis of Cristie Ford, Innovation and the State: Finance, Regulation, and Justice
(Cambridge University Press, 2017)
What if the greatest challenge facing regulation today is not erratic executive action, or lack of political will, or under-resourcing (though of course these matter)? Instead, what if the most profound and significant challenge facing regulation – not only today, but continually – is private sector innovation?
Innovation is the product of that most cherished good, human creativity. It carries with it the prospect of problems solved and diseases eradicated, of fresh adventures and a larger pie. Sometimes the debate is more nuanced, but for most people most of the time, to be anti-innovation is still to be unenlightened, fearful, backward, and blind to possibility. Change-resisters – individuals, corporations, states, even species specialists like migratory songbirds and polar bears – are doomed, often tragically, to the wrong side of history. Our public policy choices and our public dialogue endlessly reflect this, often speaking of innovativeness as if there could be no higher compliment.
Yet we should also consider innovation’s unpredictable effects on the regulatory landscape it occupies. Sometimes we fail to see the effects of innovations until they collect, as if suddenly, in unexpected locations (much as risk collected in over-the-counter derivatives markets in 2007-08). In fact, those innovations may have built up over time but only registered with us after they had reached a certain critical volume. In this way, innovation is like water: a single droplet is rarely remarkable on its own, but many droplets together matter quite a lot. Moreover, innovation runs down avenues of opportunity, whether or not those outside the innovative process recognize those avenues. Innovation will run under, around, and over obstacles (including seemingly-clear regulatory requirements).
Innovation is also like water in its potentially corrosive effect. In the language of the business scholars, it is “disruptive”. Decentralized, private sector innovation creates its own opportunities. It can open up novel and unexpected ways of working that challenge existing divisions of responsibility between regulators. It can destabilize or swamp regulatory structures, sometimes in obvious ways but sometimes in latent or inconspicuous ones. Even innovation that undermines and disrupts core components of regulation can sometimes be hard to track until it is very far along, by which point it will have gained momentum, interests and defenses will have coalesced around it, and it may have become hard to contain. If the regulatory obstacle is a rigid rules-based requirement, running around it is relatively straightforward. (Think of Enron and rules-based US GAAP accounting rules.) But the financial crisis demonstrated that more flexible or market-based regulatory regimes, like those underpinning the former Basel II Capital Adequacy Regime or the Asset-Backed Commercial Paper exemption from securities disclosure rules, are not immune to innovation’s corrosive effects.
If we want to improve regulatory effectiveness, the first step must be to get some distance from the romantic, almost magical conception of innovation that dominates popular and academic discourse. We need to recognize that innovation, almost by definition, is a profound and direct challenge to regulation in all its forms. This is the project that my recent book, Innovation and the State: Finance, Regulation, and Justice (Cambridge University Press 2017), tackles.
The familiar radical-versus-incremental-innovation dichotomy is a useful, if imperfect, place to start to think about the phenomenon. “Radical” innovations are thought to represent fundamental breaks, step changes, paradigm shifts; “incremental” innovations are the product of iteration, tweaking, and diffusion, producing gradual evolution. Accepting this for a moment, the velocity and magnitude of change that a particular innovation brings with it will change the regulatory challenges it throws up. For example, when confronted with a radical, or what I call “seismic,” innovation (the existence of which will always be a matter of degree), the main problems for regulators will be caused by lack of data, lack of comparators, and what Frank Knight in 1921 described as genuine uncertainty – the “unknown unknowns.” Think of the rapid growth of deepwater oil drilling, or the sudden explosion of cryptocurrencies and cryptocurrency markets today. This is a particular kind of regulatory problem, which demands particular kinds of regulatory solutions. For example, ex ante licensing regimes, plus effective information-forcing mechanisms, could be reasonable ways to try to slow down innovation while the regulator addresses the data scarcity problem. A brave regulator should be willing to consider them.
By contrast, most innovation proceeds in a more incremental way, through what I call “sedimentary” layers of innovation. This is exactly the kind of innovation that our regulatory scholarship, from Brandeis’s “parallel laboratories for democracy” onward, seeks to celebrate and reward. In this version, each new layer of practice or product, on its own, is fairly unremarkable. It does not trigger any alarm bells. Cumulatively, however, the layers can add up to very significant change. Think perhaps of the recent growth of social media as a force in society (and politics), or the ways in which the “business of banking” in the United States changed and expanded in stages through the late 20th century. The regulatory challenge in these cases is that, like the apocryphal story of the frog in boiling water, we fail to notice the change until we are a long way from safety. Because humans are poor at recognizing and responding to slow-moving, aggregative change in real time, that is the capacity that needs to be built into the regulatory framework itself. Rather than developing ex ante licensing regimes, for example, as one might when facing a seismic innovation, regulators might be better off focusing on developing better systems for tracking and responding to change, in real time and across time.
Innovation is a complex, multifactorial phenomenon, and developing regulatory responses to it is a challenging undertaking. The book concludes by proposing a framework of questions and strategies, drawn from its case studies, for addressing the technical challenge of regulating in the face of innovation.
Yet these are not only technical questions. Regulation is at the leading edge of politics and policy in ways that we do not always fully grasp. Seemingly innocuous regulatory design choices have clear and profound practical ramifications for many of our most cherished social commitments. Groups of people win, and lose, when innovation changes the ground rules. And financial regulation in particular is a crucial site for addressing domination in some of its most embedded and pernicious forms. Innovation must be understood not only in technical terms, but also in human ones. We need a regulatory structure that employs good technique, while also staying attuned to the broader equality, justice, and fairness concerns that animate and inform our regulatory priorities.
March 5th, 2018 (Monday) at 12:10 PM
- Professor of Law, Hitotsubashi University Graduate School of International Corporate Strategy
- Short-Term International Visiting Professor of Law, Columbia Law School
Location: Jerome Greene Hall room 602
Topic: Japan is Changing (abstract forthcoming)