Regulation vs. Innovation

A clear example of how regulation and taxation--often encouraged by special interests looking for barriers to competition--can stand in the way of innovation, and hence growth and prosperity in general in this column on FT.com by Tom Hazlett. Worth reading in whole, but here are some excerpts:

The problem for regulators is that local telephone rates today include a bloated package of regulation-induced charges. Such taxes (hidden and explicit) are generally doled out in subsidies for below-cost rural services and cheap residential connections for low-income households, and to fund such "public interest" goals as information technology for schools. The costs associated with padding users' bills - particularly in long-distance charges and business services - are ignored. The perverse outcomes embedded in this system are legion, exemplified by the poor urban-dweller who pays artificially high long-distance bills to underwrite subsidised local phone service to a CEO's Aspen ski chalet. This system constitutes what is universally known as "good politics."

Unregulated competitors wreak havoc on this jumble by injecting a dose of economic rationality. The entrants target customers paying prices fattened by regulation. Vonage's phone service, which lays atop a cable modem or DSL connection, offers home users unlimited local and domestic long-distance calling for about $35 a month. With a similar bill for broadband service, residential customers pay about a $75 monthly tab. That is far above what most households pay for phone services, but for users paying high long-distance charges - i.e. those funding the subsidies - it can be a bargain. Customers held hostage to regulation-by-taxation (as Richard Posner famously described the regulatory temptation to block competitive entry, directing the profits generated to fund popular projects) are making a break. State regulators, vigilant in protecting cross-subsidies, want to block this exodus by subjecting the new technologies to the old rules.

The states do have a legal point. Using if it looks like a duck logic, the function of VoIP is analogous to plain old telephone service. It makes little sense to subject close substitutes to distinct rules. VoIP carriers respond that their technology is completely different - but this points to re-crafting the old rules for new situations, not abandoning them altogether.

The superior argument for waiving regulatory rules for the new technology is that such regulations are barriers to entry. By eliminating taxes and regulations, we encourage the emergence of competitive services and networks. This properly focuses attention on the damage such rules inflict on investment and innovation undertaken by all providers - new entrants as well as more established, non-VoIP providers. Such damage includes under-investment in serving high-cost rural areas through efficient alternatives such as terrestrial wireless or satellite. Instead, the argument over regulatory lines becomes legalistic and arcane.