Marketcraft and the Digital Economy

Information technology has disrupted regulatory regimes and recast policy debates.

The digital economy appears to provide the closest thing to the frictionless perfect markets of economic theory to date. Yet it actually requires more extensive and intensive regulation than other markets do—not less.

Prosperity in the digital age hinges on “marketcraft,” which includes all the things governments do to make markets function and flourish, ranging from areas such as antitrust to intellectual property rights. The term marketcraft transcends the conventional juxtaposition of governments versus markets and identifies market governance as a core function of government comparable to statecraft.

The digital economy turns the logic of free markets on its head because it reveals how open, competitive, and dynamic markets require extensive government regulation. Free markets are not so much liberated from government, but rather liberated by government. Of course, this need for regulation applies to market governance more broadly, but the digital era makes the government’s role both more essential and more elaborate.

Moreover, technological advances have challenged traditional approaches to market regulation to the point where they have disrupted longstanding regulatory regimes and recast policy debates in antitrust, telecommunications, finance, and intellectual property. The nature of the disruptions and the appropriate remedies vary considerably across these issue-areas.

The digital economy challenges antitrust policy because it bestows major benefits to first movers that produce a dominant standard. Although some of the underlying dynamics—such as network effects and interdependencies among products—are not unique to the digital economy, they appear today in novel and sometimes extreme forms.

The ability of platform operators—such as Google, Amazon, or Apple—to set the terms of competition on their platforms makes the digital platform economy particularly conducive to monopoly. These dominant platform operators have challenged the prevailing U.S. antitrust doctrine, which focuses on consumer welfare defined in terms of prices rather than market structure and economic and political power more broadly. Platform operators are willing and able to sustain predatory pricing—where they set prices below a level competitors can match—for long periods of time. They seek growth over profits, and investors support them even in the absence of profits.

These distinctive features of the digital platform economy may require antitrust authorities to assess a platform operator’s market power more proactively, rather than waiting for it to raise prices. Or the authorities may have to consider regulating platform operators as utilities that provide essential market infrastructure.

The digital economy has established the Internet as the dominant communications infrastructure. Government authorities have subsequently faced the question of whether to maintain open Internet rules, also known as net neutrality, that prohibit Internet service providers (ISPs) from giving preferential access to some users over others or privileging their own content over that of others.

Openness in this case is the product of the imposition of a rule, not the lack of one. Net neutrality rules comprise restrictions that preserve freedom in the sense that they constrain ISPs from acting as gatekeepers to the flow of content on the Internet; they facilitate competition in Internet services by guaranteeing that ISPs do not subject new entrants to inferior service or demands for premium payments. In the United States, the most straightforward path to greater openness and more dynamic competition lies with a relatively heavy hand of regulation via classification of the Internet as a public utility.

Information technology has greatly enhanced the speed and lowered the cost of financial transactions, spawning new financial instruments, trading strategies, and stock exchanges that have challenged the U.S. financial regulatory regime that emerged under the New Deal in the 1930s. For example, high-frequency trading—a type of algorithmic trading strategy that relies on super-fast communications speeds—has confounded regulators because it can increase market volatility and can undermine public markets by allowing traders to earn rents at the expense of other investors.

Karen Kunz and Jena Martin of West Virginia University argue that algorithmic trading threatens the U.S. regulatory regime focused on information disclosure by firms. Trading is now based less on the value of the company than it is on the dynamics of the market, meaning that regulators need to focus more on regulating markets instead of regulating companies. Market regulation could take the form of more proactive monitoring of investment activity, including limits on trading volume or temporary shutdowns of trading. It could also mean regulating investment products from a consumer protection perspective.

The core commodity of the digital economy—information—is itself the product of rules, such as patent and copyright protection. Government authorities must strive to strike a balance between content creators and users that fosters competition, rewards innovation, and promotes the diffusion of knowledge. With the digital economy, some of the benefits of strong intellectual property rights protection have diminished while the costs have increased to the extent that a fundamental recalibration of the property rights regime may be required.

The U.S. government extended patent protection after 1980 to new products, such as software and business methods. The proliferation of patents produced a “patent thicket”—a dense web of patent rights through which companies now must hack to commercialize new technology. And patent “trolls”—companies that do not create their own inventions but rather make a business in buying up patents—have increased costs for businesses and consumers, clogged the judicial system, and impeded product development.

Meanwhile, digital technology has driven down the cost of reproducing and redistributing content virtually to zero, making copyright rules essential for content producers to earn a return. Yet copyright protection also impedes the open production model, which Yochai Benkler calls “commons-based peer production.” This model for information and culture excels with a widely distributed—rather than concentrated—physical infrastructure of computers and communications.

This review is far too cursory to justify any definitive policy recommendations, but it suggests some possible directions for reform: more proactive enforcement in antitrust, more aggressive pro-competitive regulation for telecommunications, more pre-emptive monitoring of financial markets, and more selective protection for intellectual property.

In any case, it is clear that high-quality marketcraft in each of these regulatory realms will be increasingly critical to prosperity in the digital era.