In 2012, Robert Gordon postulated the thesis that innovation was slowing to a halt, so that we should not expect to continue getting the productivity gains we had enjoyed in the 19th and 20th centuries. He propounded four “headwinds” that were causing this: demographics, education, debt and inequality. At the time he wrote, this column suggested he was somewhat too pessimistic, since there were a number of technologies on the horizon that would provide further breakthrough periods. I now think I was too optimistic; I failed (as did Gordon) to take account of a fifth headwind, stronger than all the other four, which would cause the 21st century to be very different from the previous two: the dead hand of regulation.
If Thomas Malthus had lived in an era of regulation, he would have postulated a new Malthusian law: regulation expands exponentially, whereas productivity improvements occur only linearly. Hence in a modern society regulation will always outstrip productivity growth and eventually send productivity into a decline from which there is no exit. Regulation expands from two directions: from the growth in regulatory agencies (each one has to justify its own existence) and from the creation of new economic activities (regulators and special interests can find new and hitherto unimaginable dangers in anything that hasn’t been done before.)
When regulations must pass Congress one by one, there is some chance of technology getting there first – otherwise we wouldn’t have the lightbulb. However each new agency that is established is given devolved powers by statute, after which is able to write regulations in its own area without effective Congressional supervision. The result is a proliferation of “glue in the works” regulations that add ever-more costs to the economy, slowing innovation.
The European Union has devised an even more effective barrier to technological progress, an unaccountable bureaucracy and court system that has considerable instinctive hostility to a market economy and seeks by all means to advance its control over the economies of the union’s nation states. Needless to say, with the EU now consisting of 28 members, the efforts by any one of them to resists this bureaucratic Leviathan on behalf of its own infant industries are doomed to failure.
Examples abound. Uber consists mostly of clever software to manage a taxi fleet. However in almost all cities, incumbent taxi services are able to bring sufficient pressure on the regulators to prevent Uber from taking their business. In an efficient free market, taxi services that did not have access to Uber-type technology would quickly go out of business, while new services would appear, each with a different version of the new software. Uber is thus not guiltless here; it uses the over-expansive software patent system to inhibit new entrants to its new product area of software-driven taxi services, so competition and innovation are prevented by two sets of incumbents: existing taxi services city by city and Uber itself in the software area.
Energy is an especially expensive example of regulatory overreach. Fracking, the new technology that has brought sanity to the oil market, could not be banned nationally, because the EPA were not quick enough; by the time they realized the danger of the technique to their preferred “green” future it had taken off. However the regulators were not hampered completely; New York Governor Andrew Cuomo has now announced a state-wide ban for New York, which possesses part of the Marcellus Shale which has resulted in massive new production from adjacent Pennsylvania. As a result, Binghamton, NY is condemned to continued poverty, welfare dependence and drug abuse – from last week’s other Cuomo-related announcement, it won’t even get a casino.
Every move in the market can be used by regulators as an excuse to impose their will. Now that oil prices have declined, you can bet that regulators will seek to cap the amount of fracking activity and Canadian tar sands production. They know that industry resistance to their diktats will be weakened, because many such projects are unprofitable at today’s lower prices. Even the Keystone XL pipeline, a modest and entirely environmentally benign project that has been blocked for six years of high oil prices and massive potential profitability (in 2012 this column calculated that its annual value of the XL pipeline, given the $20 difference between Canadian and U.S. oil prices, was some $27 billion, giving it a payback period of less than four months on its initial $7 billion investment) is now likely to be doomed by low oil prices.
Even if the incoming Republican Congress uses political capital to force the project’s approval, it is now very likely not to be built because in an era of low oil prices much tar sands oil is uneconomic and the U.S./Canada price differential has more or less disappeared. Needless to say, if oil prices rise again in a few years’ time, and the project’s sponsors try to revive it, the regulators will find a new way to prevent them doing so.
The financial crisis of 2008 has thrown up entirely new layers of regulation in the financial industry, most of them ineffective. When the banks wanted to remove a protection in the Dodd-Frank legislation, separating the riskier swaps from the deposit-guaranteed balance sheets of the big banks, they were able to do so. Conversely, mortgage companies are now being forced to offer mortgages with a mere 3% down-payment to borrowers who might not otherwise qualify, while the Consumer Financial Protection Bureau, an entirely new agency set up free from Congressional oversight, is every day drafting new regulations to suit some lobby or another, at the cost of increased inefficiency and costs in the market for consumer finance.
As scientific advances have grown further beyond “common-sense” comprehension, the chance of crippling regulation has grown. It’s much easier to use the public’s fears and ignorance to prevent a technological advance that has not already manifested itself. Three advances in particular seem likely to meet with a blizzard of regulatory obstacles.
First, the enthusiasm two years ago for Amazon’s announcement that it would use drones for packages delivery appears to have been misplaced; the regulators have determined that drones must be regulated by the Federal Aviation Administration, requiring a separate licensed pilot to operate each flight. This is akin to the pre-1896 British regulation requiring a man with a red flag to walk in front of each automobile; it effectively kills the new technology stone dead. One can have doubts about the desirability of unlimited droning (as I do) without wanting it to be held up unduly by this kind of bureaucratic obstruction.
A second, more important innovation that will meet with bureaucratic obstruction is that of self-driving cars. The technology is already here in embryonic form, but it is clear that the regulators will go down fighting on this one. Estimates when the cars first appeared two years ago that they could be fully in use within a decade now seem hopelessly over-optimistic, as obstacles to their development and testing are generated at all levels. Unlike drones, these could genuinely revolutionize the lives of many people, in particular the old and those with limited eyesight. Regulation may prevent that potential from ever coming to fruition.
Finally, and most important, there are the host of regulations in the field of genetic engineering. This is by far the most important group of innovations of the next 100 years, enabling us to conquer disease and aging, and possibly to improve the genetic makeup of future generations. It is however already the object of Luddite levels of regulation, to the extent that many promising fields of experimentation are illegal in the United States before they have been opened. There is some hope that the Asian countries, whose Confucian ethical backgrounds raise fewer problems with genetic manipulation than do the Abrahamic religions, may push humanity forward in this area. However even then, any advances are likely to face massive bureaucratic resistance internationally from the United States and Europe.
The inexorable decline in U.S. productivity growth over the last 40 years is no accident; it has coincided with the advances made by the regulatory state. As Leviathan’s power becomes exponentially greater, its ability to obstruct major innovation increases. New forms of social media and new cellphone games will be invented; they pose no threat to the regulatory state – but they also do little if anything to improve productivity and living standards in any fundamental way. But the major innovations that change our lives and make us all richer look increasingly likely to face permanent or near-permanent obstruction.
Thus Gordon’s nightmare of ever-slowing innovation seems likely to be fulfilled, but not because of any lack of inventiveness in the tech-savvy population, now multiplied many-fold by the spread of modern education to China, India and other emerging markets. Instead, the regulators will first slow innovation then, as they move closer to omnipotence, prevent it altogether. For the world’s living standards, Malthus’ gloomy prediction of universal immiseration will come to fruition – but through a mechanism that, writing in the loosely regulated small-government eighteenth century, he could never have imagined.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)