Unfortunately, in the physical world, entrepreneurship is often impeded by needless regulation. To take a recent, widely-cited example, Matt Yglesias relays the petty bureaucratic hassles he encountered in acquiring the requisite permission to become a mere landlord in DC. These hassles are optional, a political choice we have made—we need not license landlords at all! We should surmise that the bureaucratic headaches associated with becoming a landlord exceed whatever benefits such licensing purports to offer and deregulate this sector of the economy. While it is not immediately apparent what landlording innovations we are missing out on because of our overzealous regulation—and there may be some—lowering barriers to entry in this industry could create more competition, improve property management, and create a more efficient market.
When I preach the virtues of deregulation, I am frequently asked condescendingly: don’t we need some regulation? Without regulation, companies would shirk their responsibility to make safe and reliable products. This could result in significant damage to the environment and private property, or even loss of life. While we need to prevent the harms that businesses might impose on customers and third parties, how we prevent them turns out to matter. And it matters for the same reason that it matters that the Internet is permissionless—because permissionless systems allow for greater innovation.
Our regulatory system is permission-based. Either the specifications for permitted products and services are published in advance, or firms seek special permission to offer a product or service. This regulation has the same effect on entrepreneurship in the real world that many online regulations would have on Internet innovation. It raises the cost of starting or running a business or non-business venture, and therefore it discourages activities that benefit society.
The alternative to permission-based regulation is centuries old and well tested—the common law of tort. Under tort law, instead of asking for permission to introduce a potentially dangerous product, a firm must pay for the damages its dangerous product creates if it is found liable in court. Brilliantly, the tort system operates retrospectively—there must be actual damages before it steps in to stop the potentially dangerous activity. It is restitution-based, not permission-based. This creates an incentive to make safe products, and it keeps the barriers to starting a company or rolling out a product low.
To see how firmly entrenched the permission-based, regulate-first mindset is, and how it can affect innovation, look no further than the commercial drone industry, which would be on the verge of, ahem, taking off, were it not for the fact that all commercial drones are illegal under current FAA rules. Congress has ordered the FAA to make new regulations by 2015 that would legalize commercial drones, but even these are likely to be permission-based rather than leaving drones in the capable hands of restitution-based courts. If we deregulated this sector, commercial drone operators would still be liable if they caused damage through negligent use of these devices, under rules that courts would start to articulate as such cases arose.
Alternatively, look at the case of the Sensor Pad, a “medical device” barely worthy of the name. The device consists of two sheets of plastic with silicon lubricant in between. Despite its simplicity, the pad can help women detect breast lumps, potentially saving their lives. Yet the FDA demanded that costly clinical trials be conducted to determine the effect of the Sensor Pad on breast cancer mortality. The company that produced the Sensor Pad ultimately defied the FDA, resulting in a Congressional hearing that put pressure on the agency to approve the product, nine years after it was originally submitted.
These cases illustrate how the need to seek permission can harm innovation in the physical world, not just the virtual one. The costs of this forgone innovation are high. Left to tort-based regulation, the commercial drone industry might already be flourishing, resulting in new services, business models, companies, and jobs. And how many people died due to the unnecessary nine-year delay in approving the Sensor Pad? How many must die because other medical devices are never invented, because the existing regulatory model discourages innovation?
Advocates of the Internet are right to extol the permissionless innovation model—but they are wrong to believe that it need be unique to the Internet. We can legalize innovation in the physical world, too. All it takes is a recognition that real-world innovators should not have to ask permission either.