Regulation of Innovation and Innovative Regulation

“In 1898, delegates from across the globe gathered in New York City for the world’s first international urban planning conference. One topic dominated the discussion. It was not housing, land use, economic development, or infrastructure. The delegates were driven to desperation by horse manure. The situation seemed dire. In 1894, the Times of London estimated that by 1950 every street in the city would be buried nine feet deep in horse manure.” (From Horse Power to Horsepower -Eric Morris)

Domestication of horse has been one of the key contributors of human progress; as it provided logistics support for business, leisure, pleasure and even conquests. We are good at building on and exploiting anything that would maximise our private benefits that sooner than later the negative externalities start taking a toll to the society at large; what the economists call the tragedy of the commons.

This happened in case of Horse Power too. With exponential growth in horse drawn logistics, by the end of 19th century accidents, pollution, and health hazards associated with horse was scary and appeared un-controllable.

Then came internal combustion engines that were much less polluting (even the methane produced by horse manure is eight times more potent than CO2 from automobiles as a greenhouse gas) less accident prone, much faster and more powerful. But by the end of 20th century this saviour has grown to a monster that is ready to savour its creator as it has proliferated to almost unsustainable levels.

The same is true for most of the human innovations. In financial services the time taken for an innovation of graduate to a Frankenstein has been quite low.

For examples derivatives have been developed as a tool for hedging risk. It has grown to be an instrument not infrequently used to structure products with the sole intention of profiting from the unsuspecting investors. Credit Default Swaps and Securitisation of debt instruments contributed enormously to the maturing of debt markets and helped better resource allocation. But this was also taken to its ridiculous extent that in most cases there was nobody who really cared or owned up responsibility to assess the true cost and risks associated with the underlying assets. The recent indictment of Goldman Sachs is an example of such unfair practices.

Does it mean that we need to curtail innovations? The answer is no. It is these innovations that ensured that the Malthusian theory has turned out to be an imaginary fear and the standard of living of a significant majority of human beings across the globe is hundreds of times better than the best the select few enjoyed even a few decades ago.

But as the time goes, products of these innovations reach such gargantuan proportions with very high impact on the well being of the society especially in a ‘flat world’ as described by Thomas Friedman. With large segment of wealth under the control of few large entities who are ‘too big to fail’, the difficulty of reining their run-way exploitation of their innovations gets to be even more difficult.

Addressing these is one of the key challenges for any government. Towards this goal, firstly we need to support strong regulations and stronger regulators who do not fall prey to their megalomaniacal instincts and try to micro-manage or centrally control; but who have the intellectual capability to analyse issues to identify key levers for action, recognize practices that exploit the common investors and curtail them, have courage to take strong and often unpopular decisions, can make the institutions who screw-up to pay-up and has moral strength not to be influenced by money, power or influence and at the same time is capable to encourage and get out of the way of innovations that are game changers. The stand taken by SEBI recently with respect to Unit Linked Insurance Policies (ULIP) which is a mutual fund masquerading as insurance is an excellent case in point on the constructive role the regulator can play.

Secondly we need to enable, encourage and empower disruptive technologies, processes and products that solve problems that are critical to survival of humanity. Especially since the existing interest groups who have heavily invested in the old system will work overtime to prevent success of these innovations. For example the oil industry will be happy to ensure that till the last drop of oil is left, human beings are addicted to it and are willing to pay more and more for the less and less that is drilled or excavated out. We experienced similar resistance from custodians and registrars when we were setting up a depository for Indian Capital Market.

The governments have a major role to play here too. They have to support, encourage, fund and place enabling provisions so that innovations are allowed to take root and reach a critical mass. Only then these disruptive technologies, products and processes can manage to break the status-quo and establish better, cleaner, more efficient solutions to problems that appear to make human race a run way experiment that is ready to destroy the mother earth as we know today.

That is why the two principal challenges for the day are Regulation of Innovation and Innovative Regulation

"It has yet to be proven that intelligence has any survival value." — Arthur C. Clarke