Regulation, investment, and technology commercialization

Commercialization, when successful, creates new markets or expands existing ones. Sovereign entities can govern commercialized advanced technology industries in two ways: by dictating the rules under which the suppliers compete—“regulation”—or by funding or becoming suppliers themselves—“investment”. “Regulation” covers policy actions that work through legal mechanisms like ownership or obligation, while “investment” covers policy actions that work through physical mechanisms like plant and training.1 The Regional Greenhouse Gas Initiative? Coordinates state-level emissions reductions, any changes to physical plant or workforce are incidental, regulation. Title 17 Clean Energy Financing? Gives firms money to build and produce clean energy things, meant to increase physical plant and develop workforce, investment. Public utility commissions and the Sherman Act are regulation. The Tennessee Valley Authority is investment. “Market design” is regulation. “Industrial policy” is investment.

Sovereign demand is a separate category. Sovereign oligopsonists can, of course, influence suppliers’ conduct. They can use their demand to complement regulation or investment. But their power is proportional to their relative share of total demand. If the sovereign’s preferred notion of commercialization involves expanding the customer base, their goal imposes natural constraints on their ability to use their demand to govern the market. On the other hand, advanced technologies initially built for buyers of exceptionality can be a bit finicky to mass produce. If small changes in a technology’s characteristics degrade its functionality more than they reduce its costs, the addressable customer base may be too small to support the desired extent of commercialization.2 In these cases sovereign oligopsonists are, for better or worse, mostly stuck wielding their influence.3 One way or another, heavy use of sovereign demand is unlikely to be a significant feature of successful advanced technology commercialization and industry or market governance strategies.

At a very high level, regulation appears best suited to “large” or “robust” markets. Regulations can be adapted relatively quickly and cheaply to a large number of cases. Find an exception? Write an exemption. Of course it’s never quite that simple, but if you know what you’re trying to do and can get enough agreement, it’s a reasonable approximation. Correctly or not, people tend to think they both know what they’re doing and can convince others it’s a good idea.

Similarly, investment appears best suited to “small” or “critical” markets. Investments can ensure certain things get built and provide scaffolding for firms to experiment with business models. But it’s expensive. Find an issue? Even in the best cases you may incur costly change orders; in worse cases your plans may not be salvageable. Even if you know what you want to do and have a consensus behind you, the direct costs of the action and perceived uncertainty from the future cast shadows over plans for investment-centric market governance.

In drier terms, investment is a planner’s economic control surface. It directly links plans and the real economy. When a sovereign invests they are changing the real economy and shaping a technology’s production and consumption possibility sets. Investments in the real economy are challenging to manage, though. Regulation is a legal abstraction layer for investment. Like a good abstraction, it makes it easier to work with the underlying system. Like any abstraction, some information is lost between layers. Minding this slippage is (was?) an essential part of good technocratic market governance.

“de/regulate” in American folk economics

“The virtues of regulation / deregulation” have been staples in American4 folk economics5 for at least the last 40 years. Sometimes it’s trade barriers, or intellectual property agreements, or investor-state dispute settlement rules, or some other thing that amounts to a change in the legal interfaces to the real economy. Two narrative forces supporting these behaviors seem worth calling out specifically.

First, as I mentioned, changing regulations often appears cheaper than investing. “All” you need to do is change words on paper! Economic analysis can highlight how regulations will change real factors and budgets, but American folk economics over this period has also deeply internalized that all government spending derives from taxes. Ideally, changing words is not only cheap but reduces the cost of government functions. Sometimes reducing government functions is part of a strategy to transition those functions to private actors, which (in theory) also ought to reduce government spending. Even if the typical American doesn’t adjust their spending to exactly offset changes in fiscal policy and the trajectory of interest rates, Ricardian equivalence begets digestible memes.

Second, narratives that emphasize regulation also suggest, subtly or less so, that any shortfall in market activity is not due to a lack of opportunity or a need for greater sovereign control over the economy. American folk economics tends to view the nation’s latent entrepreneurialism and dynamism as limitless, or at least substantially greater than is visible {presently}.6 Narratives that emphasize regulation as a commercialization lever therefore tend to complement appeals to historical or otherwise-not-{presently}-observed greatness.

Whatever the causes, persistent strains of thought in American folk economics argue that government investments crowd out private investments and that regulations or their absence prevent firms from pursuing all technically feasible opportunities. Advanced technology commercialization, per these arguments, is therefore best structured as a program to systematically deregulate and pull “the government” out of “the market.” With government out of the way markets will flourish and produce ever-tastier fruits, presumably with those new gizmos provided by the heroic entrepreneurs. Partnerships of all types will flourish as they become less burdensome, partly due to greater private sector innovation and partly due to less public sector interference. Utopia beckons. The tidiness of such stories obscures their basic logical incoherence.

Profits motivate profit-seekers

The kind of commercialization I’ve been describing is intended to create opportunities for firms to supply the fruits of advanced technologies. Firms, famously, seek profits. If you want firms to enter a market, you have to make it look profitable. Adding regulation or increasing the scale of investment can support profitability, as can deregulation or disinvestment. The details always depend, with one exception: vacillation is the market killer. Decisive commitment to a second-best strategy dominates weak commitment to a first-best approach. Ultimately, commercializing advanced technologies requires sovereigns to manage uncertainty about the profitability of associated ventures. Regulation can do this many ways, including by spurring new demand from non-sovereign actors.7 Investment tends to do this by offsetting fixed costs, e.g., shared infrastructure or technology transfers.

But as the United States is learning, regulation can be unsettlingly time inconsistent. The relative ease with which it is initiated underlies the ease of its deconstruction. You don’t need to send workers to the plant to tear it down; you simply write new words on new paper invalidating the old words on the old paper. Still, even if regulations that authorized particular investments are removed, much physical and human capital can remain. Investments are not necessarily more time consistent, but they tend more often to create facts on the ground that make future decision makers loath to undo them. Sunk costs and endowment effects are powerful.

This, in short, is the incoherence in American folk economics stories about regulation and advanced technology commercialization. Even when regulation or deregulation gets firms to anticipate profits from entering a market, it neither helps them develop the capacities to actually compete nor does it provide much certainty about the returns on their investments. Sure the domestic supply mix needs to use this new widget by the end of the decade, but at what price? What if I don’t finish production in time? What about the international market, are they also looking for this kind of widget? These issues multiply in partnerships between sovereigns. All the latent dynamism in the world won’t make profit-seekers give up safe rents in “normal” markets to chase risk in nascent ones. Investment can directly support capacity development and reduce uncertainty, so is often a more fruitful avenue to commercialize advanced technologies. But public investment also often looks like the opposite of commercialization under American folk economics.

As dominant sovereigns retreat from advanced technology leadership, I expect successful commercialization partnerships will increasingly select for investments over regulations. Regulatory partnerships, like cross-border emissions or electricity markets, will decline in prevalence relative to investment partnerships like joint ventures or financial engineering schemes. It remains to be seen whether or when American folk economics reflects this shift.

  1. As of this writing, U.S. federal government benefit-cost analysis of “regulation” happens under OMB Circular A-4 while benefit-cost analysis of “investment” happens under OMB Circular A-94. 

  2. The nature of most advanced technologies—expensive and long development, uncertain and limited demand—also selects for oligopolies. Sovereigns must often treat advanced technology industries as substantially public if they are to exist at all, let alone grow. Governance problems in these markets are often bilateral monopoly problems in another guise. 

  3. Heavy-lift rockets are in this category. I would classify the National Security Space Launch program as “investment” even though it uses U.S. national security demand to shape the launch market. 

  4. I see something similar in the UK; comparative and root cause analyses are left as exercises. 

  5. By “folk economics” I mean the common intuitions about how the economy works held by people untrained in formal economics. That folk economics supports an idea doesn’t mean the idea is wrong or useless. For example, Ricardian equivalence is compatible with many American folk intuitions about the economy. Even though some prominent works have rejected the hypothesis in the U.S. in the last century, the equivalence remains both a null model for certain applications and an empirical hypothesis to test in others. On the other hand, American folk economics tends to view the federal government budget like a household’s budget, which is still interesting but in more of a “wow that’s really wrong and unhelpful” way. 

  6. The {present} dormancy is often attributed to “Those Idiots In {place},” usually a city with some context-relevant decision authority. 

  7. This is common for environmental technologies that control negative externalities: by setting the acceptable level of (say) pollution at a lower level than the market would produce on its own, the state ensures a certain level and distribution of demand for relevant pollution control technologies. The tax code is a convenient tool to change relative costs and guide others’ investments.