Regulate? Innovate!

Suddenly, we live in a world of policy dilemmas around social media, digital platforms, personal data, and digital privacy. Voices on both sides of politics are loudly proclaiming we ought to regulate Facebook and Google. From the left, these calls focus on antitrust and competition law—the big platforms are too large, too dominant in their respective markets, and governments need to step in. From the right, conservatives are angry that social media services are deplatforming some popular voices and call for some sort of neutrality standard to be applied to these new ‘utilities’.

Less politically charged but nonetheless highly salient are the concerns about the collection and use of personal data. If ‘data is the new oil’—a commodity around which the global economy pivots—then Facebook and Google look disturbingly like the OPEC oil production cartel. These firms use that data to train artificial intelligence (AI) and serve advertisements to consumers with unparalleled precision. No more is it the case that 50 per cent of advertising is wasted.

These policy dilemmas have come about because the digital environment has changed, and it has changed sharply. Facebook only opened to the public in 2006 and by 2009 already had 242 million users. In the second half of 2019 it has 2.38 billion users.

Facebook is not just central to our lives—one of the primary ways so many of us communicate with family, friends and distant acquaintances—but central to our politics. The first volume of the Mueller investigation into Russian interference in the 2016 American presidential election focused on the use of sock-puppet social media accounts by malicious Russian sponsors. There’s no reason to believe these efforts influenced the election outcome but it is nonetheless remarkable that, through Facebook, Russian agents were able to fraudulently organise political protests (for both left and right causes)—sometimes with hundreds of attendees—by pretending to be Americans.

There always have been and always will be a debate about tax rates, free trade versus protectionism, monetary policy and banking, Nanny State paternalism, or whether railways should be privatised or nationalised. The arguments have been rehearsed since the 19th century, or even earlier. But we are poorly prepared not just for these topics of digital rights and data surveillance, but for new dimensions on which we might judge our freedoms or economic rights.

Private firms are hoovering up vast quantities of data about us in exchange for providing services. With that data they can, if they like, map our lives—our relationships, activities, preferences—with a degree of exactness and sophistication we, as individuals, may not be able to do ourselves. How should we think about Facebook knowing more about our relationships than we do? Do we need to start regulating the new digital economy?

The surveillance economy

One prominent extended case for greater government control is made by Shoshana Zuboff, in her recent book The Age of Surveillance Capitalism: The Fight for a Human Future at the New Frontier of Power (PublicAffairs, 2019). For Zuboff, a professor at Harvard Business School, these new digital technologies present a new economic system, surveillance capitalism, that “claims human experience as free raw material for translation into behavioural data”.

Zuboff argues these new firms look a lot like the industrial behemoths of the 19th and 20th century. Google is like General Motors in its heyday, or the robber barons of the Gilded Age. Using Marxist-tinged language, she describes how firms claim the ‘behaviourial surplus’ of this data to feed AI learning and predict our future desires—think Amazon or Netflix recommendation engines.

More sinisterly in Zuboff’s telling, these firms are not simply predicting our future preferences, but shaping them too: “It is no longer enough to automate information flows about us; the goal now is to automate us.” Netflix can put its own content at the top of its recommendation algorithm; Pokémon Go players tend to shop at restaurants and stores near the most valuable creatures.

Where many people spent years worrying about government surveillance in the wake of Edward Snowden’s leaks about the National Security Agency, she argues NSA learned these techniques from Google—surveillance capitalism begets surveillance state. At least the NSA is just focused on spying. Silicon Valley wants to manipulate: “Push and pull, suggest, nudge, cajole, shame, seduce,” she writes. “Google wants to be your co-pilot for life itself.”

Harrowing stuff. But these concerns would be more compelling if Zuboff had seriously engaged with the underlying economics of the business models she purports to analyse. Her argument—structured around an unclearly specified model of ‘surveillance assets’, ‘surveillance revenues’, and ‘surveillance capital’—is a modification of the internet-era adage, “If you’re not paying for the product, you are the product”. Many services we use online are free. The platforms use data about our activities on those platforms to make predictions—for example, about goods and services we might like to consume—and sell those predictions to advertisers. As she describes it:

… we are the objects from which raw materials are extracted and expropriated for Google’s prediction factories. Predictions about our behaviour are Google’s products, and they are sold to its actual customers but not to us. We are the means to others’ ends.

 … the essence of the exploitation here is the rendering of our lives as behavioural data for the sake of others’ improved control of us.

This argument misses a crucial step: what is this control? For the most part, the product derived from our data that is sold to other firms is advertising space: banner ads on news websites, ads dropped into social media feeds, ads threaded above our email inboxes. Seeing an advertisement is not the same as being controlled by a company. The history of advertising dates back at least to Ancient Rome. We are well familiar with the experience of companies trying to sell us products. We do not have to buy if we do not like the look of the products displayed on our feeds. It’s a crudely simple point, but if we do not buy, all that money—all that deep-learning technology, all those neural networks, all that ‘surveillance’—has been wasted.

Two sided markets

So how should we think about the economics of the big technology companies? Google and Facebook are platforms; what Nobel-winning economist Jean Tirole described as ‘two-sided’ markets. Until recently the dominant market structure was a single-sided market: think a supermarket. A supermarket has a one-directional value chain, moving goods from producers to consumers. Goods are offered to customers on a take-it-or-leave-it basis. In a two-sided market, customers are on both sides of the market. The service Google and Facebook provide is matching. They want advertisers to build relationships with users and vice-versa. Since the first scholarly work done on two-sided markets, economists have observed platforms that take three or more groups of users and match them together.

Two-sided markets are not new, of course. Newspapers have traditionally done this: match advertisers with readers. Banks match borrowers with lenders. French economics professor Jean Tirole’s first work looked specifically at credit card networks. But two-sided markets dominate the online world, and as the economy becomes more digital they are increasingly important. When we try to define what is unique about the ‘sharing economy’, we’re really just talking about two-sided markets: AirBnB matches holidaymakers with empty homes, Uber matches drivers with riders, AirTasker matches labour with odd jobs. Sometimes single and two-sided markets co-exist: Amazon’s two-sided marketplace sits alongside its more traditional online store.

The economic dynamics of two-sided markets are very different dynamics to what we are used to in the industrial economy. They are strongly characterised by network effects: the more users they have on both sides, the more valuable they are. So firms tend to price access in strange ways. Just as advertisers subsidised the cost of 20th century newspapers, Google and Facebook give us free access not because we are paying in personal data but because they are in the relationship business. Payments go in funny directions on platforms, and the more sides there are the more opaque the business model can seem.

An ironic implication of Zuboff’s arguments is that her neo-Marxian focus implicitly discounts what most analysts identify as the two key issues around these platforms: whether these networks are harmful for privacy and whether they are monopolistic.

First, the monopoly arguments. In Australia the ACCC has been running a digital platforms inquiry whose draft report—released in December 2018—called for using competition law against the large platforms on the basis they have started to monopolise the advertising market. There are many problems with the ACCC’s analysis. For example, it badly mangles its narrative account of how newspaper classifieds migrated online, implying Google and Facebook captured the ‘rivers of gold’. In fact, classified advertising went elsewhere (often to websites owned by the newspapers, such as Domain).

Yet the most critical failure of the ACCC is its bizarrely static perspective of an incredibly dynamic industry. True, platform markets are subject to extreme network effects—the more users, the more valuable—but this does not mean they tend towards sustainable monopolies. Far from it. There are no ‘natural’ limits to platform competition on the internet. There is unlimited space in a digital world. The only significant resource constraint is human attention, and the platform structure gives new entrants a set of strategic tools which can help jump-start competition. Using one side of the market to subsidise another side of the market helps ‘boot-strap’ network effects.

Consumer harm is the standard criteria for whether a firm is unacceptably monopolistic. Usually this means asking whether prices are higher than they would be if the market was more contested. Given the money prices for these services are often zero, that’s hard to sustain. Nobody pays to use Google.com. At first pass the digital platform business seems to have been an extraordinary boost to consumer surplus.

But, again, platform economics can be strange. It is possible we are paying not with money but with personal data, and the role of a competition authority is to protect our privacy as much as our wallet. This is the view of the ACCC (at least in its December 2018 draft report) and has become an article of faith in the ‘hipster antitrust’ movement in the United States that competition regulators need to focus on more than just higher prices.

There is obviously a great deal to privacy concerns. In a recent book, The Classical Liberal Case for Privacy in a World of Surveillance and Technological Change (Palgrave Macmillan, 2018), I argued we currently are in an extended social negotiation about the value of privacy and its protection. But the privacy debate is characterised by a lot of misconceptions and confusions. Privacy policies and disclosures have not always been acceptable. Expectations are changing. Mark Zuckerberg would no longer get away with the reckless anti-privacy statements he made as a CEO when Facebook launched. The question is whether to wait for privacy expectations to shift—supplemented by the common law—or whether governments need to step in with bold new privacy regulation.

The experience with privacy regulation so far has not been great. The European Union’s General Data Protection Regulation presents the single most significant attempt to regulate privacy thus far. The GDPR, which became enforceable in 2018, requires explicit and informed consent of data collection and use, informing users about how long their data will be retained, and provides for a “right of erasure” that allows users to require firms to delete any personal data they have collected at any time. The GDPR was written so broadly as to apply to any company that does business with any European citizen, in practice making the GDPR not just a European regulation but a global one.

Early evidence suggests host of consequences unforeseen by the GDPR’s designers. Alex Stapp, at the International Center for Law and Economics, argues GDPR compliance costs have been “astronomical”. Microsoft put as many as 1,600 engineers on GDPR compliance, and Google says they spent “hundreds of years of human time” ensuring they follow the new rules globally. These firms have the resources to do so. One consequence of high compliance costs has been to push out new competitors: small and medium internet companies that cannot dedicate thousands of engineers to regulatory compliance. As Stapp points out, it’s not at all clear this trade-off for privacy protection has been worth it: regulatory requirements for things such as data portability and right of data access have created new avenues for accidental and malicious access to private data.

A peculiarity of the history of early-stage technologies is they tend to trade off privacy against other benefits. Communications over the telegraph were deeply insecure before the widespread use of cryptography; early telephone lines (‘party lines’) allowed neighbours to listen in. Declaring privacy dead in the digital age is not just premature, it is potentially counterproductive. We need sustained innovation and entrepreneurial energy directed at building privacy standards into technologies we now use every day.

The deplatforming question

One final and politically sensitive way these platforms might be exercising power is by using their role as mediators of public debate to favour or disfavour certain political views. This is the fear behind the deplatforming of conservatives on social media, which has seen a number of conservative and hard-right activists and personalities banned from Facebook, Instagram and Twitter. Prominent examples include the conservative conspiracist broadcaster Alex Jones, his co-panellist Paul Joseph Watson, and provocateur Milo Yiannopoulos. Social media services also have been accused of subjecting conservatives to ‘shadow bans’—adjusting their algorithms to hide specific content or users from site-wide searches.

These practices have led many conservative groups who usually oppose increases in regulation to call for government intervention. The Trump administration even launched an online tool in May 2019 for Americans to report if they suspected “political bias” had violated their freedom of speech on social media platforms.

One widely canvassed possibility is for regulators to require social media platforms to be politically neutral. This resembles the long-discredited ‘fairness doctrine’ imposed by American regulators on television and radio broadcasting until the late 1980s. The fairness doctrine prevented the rise of viewpoint-led journalism (such as Fox News) and entrenched left-leaning political views as ‘objective’ journalism. Even if this was not an obvious violation of the speech rights of private organisations, it takes some bizarre thinking to believe government bureaucrats and regulators would prioritise protecting conservatives once given the power to determine what social media networks are allowed to do.

Another proposal is to make the platforms legally liable for content posted by their users. The more the platforms exercise discretion about what is published on their networks, the more they look like they have quasi-editorial control, and courts should treat them as if they do. While this would no doubt lead to a massive surge in litigation against the platforms for content produced by users, how such an approach would protect conservative voices is unclear: fear of litigation would certainly encourage platforms to take a much heavier hand, particularly given the possibilities of litigation outside the United States where hate speech and vilification laws are common.

The genesis of this proposal seems to come from a confusion about the distinction between social media platforms and newspapers. Newspapers solicit and edit their content. Social media platforms do not. Social media platforms come from a particular political and ideological environment—the socially liberal, quasi-libertarian and individualistic worldview of Silicon Valley and the Bay Area—and these technologies now hold the cultural high-ground. The conservative movement has focused on trying to change Washington DC when it should have been just as focused on developing new ways for people to exercise their freedom, as has Silicon Valley.

But regulation cannot be the answer. Regulation would dramatically empower bureaucrats, opening up new avenues for government intervention at the heart of the new economy (any proposed regulation of Facebook’s algorithm, for instance, would lay the foundation for regulating Amazon’s search algorithm, and then any firm that tries to customise and curate their product and service offerings), and threatening, not protecting, freedom of speech. To give government the power to regulate what ought to be published is a threat to all who publish, not to just a few companies in northern California.

Platform to protocol economy

I opened this article with a discussion of how recent a development the platform economy is: a decade old, at best. A host of new technologies and innovations are coming that challenge the platforms’ dominance and might radically change the competitive dynamic of the sector. New social media networks are opening all the time. Many of those who have been deplatformed have migrated to services such as Telegraph or specially designed free speech networks such as Gab. Blockchain technology, for instance, is a platform technology as a decentralised (no single authorities, public or private, can control its use) and open (anyone can join) protocol.

Likewise, intense innovation focusing on decentralised advertising networks threatens Google’s ad sector dominance, and offers advertisers more assurance their digital dollar is used well. Other new technologies focus on regaining control over user privacy. Cutting-edge privacy technologies such as zero-knowledge proofs open massive opportunities for hiding personal information while still participating in economic exchange and social interactions. Blockchain applications are being developed to give users genuine control over data and facilitate the sort of private property rights over information the European Union’s GDPR awkwardly tries (and fails) to create.

The platforms know they face an uncertain and more competitive technological future. That is why Facebook is developing its own cryptocurrency—a pivot into financial services, like Chinese social media WeChat developing WeChat Pay. Google is investing serious resources into blockchain research, despite the technology’s long-run potential to displace its competitive advantages. The internet 10 years on will look very different—not because governments decided to regulate, but because digital entrepreneurs will have kept pushing, bringing us new products and services, revolutionising the global economy.

Cryptodemocracy: How Blockchain Can Radically Expand Democratic Choice

With Darcy WE Allen and Aaron M Lane. Lexington Books, 2019

This book investigates the theoretical and practical implications of blockchain and other distributed ledger technologies for democratic decision making. What new structures of democracy does blockchain technology enable? A cryptodemocracy is cryptographically-secured collective choice infrastructure on which individuals coordinate their voting property rights. Drawing on economic and political theory, a cryptodemocracy is a more fluid and emergent form of collective choice. This book examines these theoretical characteristics before exploring specific applications of a cryptodemocracy in labor bargaining and corporate governance. The analysis of the characteristics of a more emergent and contractual democratic process has implications for a wide range of collective choice.

Coming soon from Lexington Books

Facebook’s monetary revolution

With Sinclair Davidson and Jason Potts

With its new digital money, Libra, a Facebook-led global consortium has created the world’s first private international reserve currency.

Announced on Wednesday, this is no small thing. For the first time since the collapse of the Bretton Woods system there is a clear competitor to the US dollar for global dominance in the currency market.

For simplicity’s sake think of Libra as a return to the global gold standard. But rather than governments setting the rules and exchange rates, with gold being the underlying store of value, we’re seeing a private organisation setting the rules and a portfolio of relatively risk-free assets playing the role of gold.

To be clear – Libra is not a cryptocurrency like, say, Bitcoin; but it has many Bitcoin-like characteristics. It is a private money. It is not government money – ultimately fiat is backed only by the taxing powers of the state. Libra will be backed by tangible assets.

Rather than Bitcoin, Libra is more like PayPal, or WeChat Pay, on steroids – a payment gateway and a new money system all rolled into one. This is perhaps a good halfway house to introduce the world to the concept of non-government digital money.

The implications are huge. Facebook has disrupted digital money in a way central banks and the commercial banking system never could. Facebook has brand recognition that even the global banks must envy.

For those consumers who may baulk at using Facebook to transact, other large tech companies cannot be far behind with their own products. So what now?

We predict a large uptake in these digital money products. Largely because consumers tend to emphasise convenience. Libra will very quickly achieve global acceptance among consumers and merchants. If that prediction comes true, many other firms will launch their own competing monetary systems. In short, there is going to be a lot of competition in this space in the very near future.

The short-term consequences include the immediate disruption of the remittance market. Those companies charging exorbitant fees to move money around the world will see their rivers of gold drying up. Debit cards will also quickly become redundant – accelerating the move to phone-based tap and pay systems. The world’s “unbanked” will quickly become “banked”.

There are other immediate practical concerns. Within the next year, both Australian consumers and merchants will be wanting to use Libra. How will this be done? How will it be taxed? Will it be taxed? But any work that has been done so far on these questions has come in the context of Bitcoin and cryptocurrency – an extremely niche market. A general use private money has simply not been on the radar.

Those central banks that tolerate high rates of inflation will see disintermediation. Governments that pursue irresponsible fiscal policies will see even greater capital flight. Ironically the presence of a convenient, sound and private digital money will provide incentives to institutionally challenged governments to lift their game or lose total control over their domestic policy environments.

Every country in the world faces policy challenges from a viable private international reserve currency. Control over the monetary system lies at the heart of the modern economy. A viable alternative to fiat currency, with international mobility, undermines both the conduct of monetary policy and fiscal policy.

No doubt governments and their regulators will be looking very closely at Libra. They may treat it as a threat. But it is an opportunity for a forward-thinking government. It should come as no surprise that Libra is being set up in Switzerland. They have sensible laws relating to financial matters. The question we should be asking is why Australia isn’t being considered as a location for these products?

Australia should consider becoming a currency haven. Not only should a suite of policies be developed that facilitates the use of a private international reserve currency within Australia, a suite of policies that attracts the providers of such currencies to Australia should be considered. The use of Australian markets to purchase the underlying assets should encouraged and especially the inclusion of Australian assets in those portfolios should be encouraged.

With the announcement of Libra, the global monetary system – and arguably the structures of global financial capitalism – changed irreversibly. And just 10 years after the invention of Bitcoin and blockchain technology. The rate of disruptive innovation is only going to accelerate.

How well Australia adapts to this change will be determined over the next six months. Libra is coming in 2020. Regulatory obstruction is simply not an option.

Blockchain and the manufacturing industry

With Darcy Allen and Jason Potts

Bitcoin was invented in 2008 by Satoshi Nakamoto as a censorship-resistant cryptocurrency built for the internet. With regular fiat money centralised bodies such as banks and governments control the records of who owns what. For bitcoin those records are held in a decentralised blockchain. Blockchains are updated and maintained by a decentralised network. To ensure the transactions and records are correct, economic incentives to continually drive the blockchain network towards consensus.

Applications of blockchain extends beyond records of money. We rely on trusted third parties to maintain our registries, enforce our contracts, and maintain our records. Entrepreneurs are now discovering which roles carried out by third parties such as governments and firms will be shifted towards blockchain-based decentralised networks.

Blockchain is now being applied to trace goods along supply chains, to give control of medical records to patients, and to create decentralized identities that help people move across borders.

What does blockchain mean for Australia’s manufacturing industry?

At first glance manufacturers produce physical products and then transport those goods to consumers. More deeply, the manufacturing process is heavily reliant on databases of information in multiple directions along their supply chains. This is especially true for advanced manufacturing. When goods and inputs move, information about them must move too. This includes information about the provenance of sub-components and intermediate parts, information about the integrity of rare products prone to counterfeit, and information about ethical standards in production.

It’s harder to produce this supply chain information than you think. The information must be coordinated between hundreds of parties in the supply chain. Most of those parties don’t know or trust each other. And this information is still often paper-based or siloed within organisational hierarchies. The result is a trail of information about manufactured goods that is prone to error, fraud and loss. And these problems only get worse as supply chains get longer in a globalised world, and manufactured goods become more complex.

Blockchain technology presents a different way to govern supply chain data that centres on the movement of the good itself. Rather than passing pieces of paper between supply chain participants to track goods, information can be recorded in a decentralised blockchain. In practice goods are given a digital representation. Then as the goods move, information about them is timestamped in an immutable blockchain. Importantly this information is stored outside of organisational boundaries, making blockchain an alternative mechanism to solving the age-old problems of provenance and quality. What information is stored in a blockchain could be the historical location of a good, who produced it, how it has been stored, and who has finance on the goods.

Supply chain information extends beyond a single supply chain. To produce a complex product involves first mining raw materials, transforming those into intermediate parts, before manufacturing of the final good. Blockchains are critical here because they can track goods and components across multiple supply chains, giving more visibility and traceability deeper into complex manufactured goods.

Blockchain supply chains will leverage other frontier technologies such as the Internet of Things (IoT). Containers and products will contain sensors to record information such as GPS location and temperature. This information won’t be sent to a centralised party, but recorded cryptographically into a blockchain. This information can help consumers in verifying genuine products, assist producers in creating analytics of consumer demand and ensuring their inputs are legitimate, and governments in ensuring compliance with domestic rules and regulations.

The first and most obvious application of blockchain in supply chains has been in agricultural products such as wine, meat and seafood. The common characteristic of these goods is that they are information-rich. Information about their provenance and stewardship is often hard to verify by observing the final goods, but radically affects the price that consumers will pay.

This means the next wave of applications is likely to be other high-value information-high goods. Goods that are highly-customised, such as 3D printed medical devices, aeroplane parts and pharmaceuticals, are perfectly poised to apply blockchain technology.

Blockchain in advanced manufacturing is more than just tracking goods once they’ve been produced. We can use blockchains to coordinate the highly valuable digital files that sit behind many of these products. How can you ensure that the CAD file being 3D printed was the one originally intended? Similarly, blockchains are being used for intellectual property rights, helping to ensure compliance in an increasingly digital world.

In the physical manufacturing process itself blockchain can be used to record information about the lifecycle of manufacturing equipment. We can now have more cost-efficient and credible auditable ledgers that extend beyond organisational hierarchies.

What we have proposed here is a general movement away from intermediaries being trusted to maintain information about goods and their production, towards information governance through decentralised blockchain platforms. To be sure, many of these applications are in the trial and experimental phase. But they represent an early fundamental shift in how we organise information across the entire manufacturing supply chain.

Blockchain and the New Economics of Healthcare

With Darcy W E Allen, Anastasia Pochesneva and Jason Potts

Abstract: In this paper we outline the economics of healthcare as a problem of coordinating data and examine how blockchain technology might be applied as new economic infrastructure to govern those data rights. We argue that blockchain as a technology of trust pushes the economic organisation of healthcare data away from large, centralised hierarchical organisation towards decentralised, emergent platform organisation. The fundamental problem in healthcare is the coordination and governance of information around decision making (e.g. patient records, licensing of professionals, medical trial data, supply chains). The new economics of healthcare emphasises how this information is governed (e.g. through firms, governments, markets, blockchains) and how the most effective governance changes through time as new technologies of trust are developed. We examine the potential of blockchain as new healthcare data infrastructure (including ensuring the integrity of pharmaceuticals and devices, medical records and data markets). Our view is that blockchain fundamentally shifts healthcare data property rights away from centralised third parties (e.g. hospitals, companies, governments) towards decentralised data property rights held by individual patients. The future platform-based healthcare ecosystem will act as the foundational institutional infrastructure for new competitive solutions to healthcare problems (powered up through other technologies such as the Internet of Things and Artificial Intelligence), helping to solve a growing healthcare productivity crisis.

Available at SSRN

International policy coordination for blockchain supply chains

With Darcy Allen, Sinclair Davidson, Mikayla Novak and Jason Potts. Published in Asia & The Pacific Policy Studies, 30 May 2019

Abstract: From the adoption of the shipping container to coordinated trade liberalization, reductions in trade costs have propelled modern globalization. In this paper, we analyse the application of blockchain to reduce the trade costs of producing and coordinating trusted information along supply chains. Consumers, producers, and governments increasingly demand information about the quality, characteristics, and provenance of traded goods. Partially due to the risks of error and fraud, this information is costly to produce and to maintain between dispersed parties. Recent efforts have sought to overcome these costs—such as paperless trade agendas—through the application of new technologies. Our focus is on how blockchain technology can form a new decentralized economic infrastructure for supply chains by governing decentralized dynamic ledgers of information about goods as they move. We outline the potential economic consequences of blockchain supply chains before examining policy. Effective adoption faces a range of policy challenges including regulatory recognition and interoperability across jurisdictions. We propose a high‐level policy forum in the Asia‐Pacific region to coordinate issues such as open standards and regulatory compatibility.

Available at Wiley Online.

Why Blockchain Technology Could Be the Key to Solving the Developing World’s Biggest Problems

With Darcy Allen

The core of the free market explanation for global poverty is simple and compelling: much of the world’s poor are poor because of institutional failure.

The court systems that service the bottom billion are unreliable or hard to access. The governments impose extractive taxation. The bureaucracies are corrupt.

And some institutions are simply missing in the developing world. A lack of reliable identity services makes it hard to access financial markets. A lack of property titles, as Hernando de Soto famously wrote, makes it hard to use the capital embodied in homes.

Corruption and Monopolies

These explanations are all true. But the free market response to global poverty is insipid to the point of uselessness. Faced with evidence that institutions in developing countries are corrupt, classical liberals respond: well, don’t be so corrupt.

There are other responses, of course. We sometimes adopt the Washington Consensus approach—use the levers of political globalization to force reform on unwilling populations. Or maybe we just hope for a revolution that might turn out liberal. Neither alternatives have good track records.

The problem here is that institutions tend to be monopolies. One country has one court system, one bureaucracy in charge of property titles, one authority giving out birth certificates. To get better institutions, we have to replace the corrupt old ones, and that’s hard to do, especially given the intransigence of rent-seekers who benefit from them.

Institution Innovation

What the developing world needs is a technology of institutions—a way not to replace institutions but to create more of them, experimentally and entrepreneurially.

This is what we see in the blockchain. Blockchain technology is an institutional technology that allows multiple institutions to operate in one place. It is perfectly suited to hostile institutional environments.

There’s been a lot of work, unsurprisingly, on individual blockchain applications that might be helpful for the world’s poor: supply chains, democratic governance, and identity management for example. With these applications, blockchain might allow poor countries to leapfrog some of the stages of development—a poor country might skip the creation of the centralized institutions characteristic of the rich world and instead adopt immediately decentralized ones.

These applications don’t need to replace their competitors, and they are virtually impossible for the beneficiaries of the old order to prevent.

But we think blockchain technology offers something more fundamental than these specific applications.

It offers the possibility of creating new institutions—new algorithmic legal systems, contract dispute resolutions systems, identity technologies, mutual welfare and insurance, and public goods provision—in competition with the existing set of institutions.

For instance, the invention of a smart contracting platform could compete with existing court systems, helping to overcome the problems of hold-up or counterparty risks. The contracting parties to decide which institutional structure they wish to use—the terrestrial one or a near-infinite number of new digital alternatives.

These applications do not need to replace their competitors to function. And they are virtually impossible for the beneficiaries of the old order to prevent.

Institutional Layering

We call this process institutional layering. Blockchain institutions co-exist with existing institutions, effectively layering on top.

Blockchain entrepreneurs in developing economies don’t require international aid agencies or development experts to define economic problems and try to solve them. Rather, they apply their entrepreneurial judgment and skills to define institutional problems and use blockchains to design and test new institutional solutions.

William Easterly famously outlined the distinction between “planners” and “searchers” in economic development. Development economics has been plagued by planners implementing top-down institutions that don’t match local conditions and have a raft of unintended consequences.

Instead of working within the existing institutions, entrepreneurs can use blockchain to operate more effectively.

The capacity of entrepreneurs to search, however, is constrained by the transaction costs they face and the technologies they have available. Rather than propelling institutional change through centralized planners (whether it be through conquest or special economic zones), blockchain enables a new decentralized process of search.

Rather than forming businesses within the existing institutions, entrepreneurs can use the blockchain to more effectively operate on the level of the institutions themselves. Blockchain enables institutional entrepreneurs to search by operating on the governance or “protective-tier” level of entrepreneurship.

Now entrepreneurs can search, discover, and deploy new governance mechanisms. They can attract users by better economizing on transaction costs than alternatives.

Polycentric Institutions

The process of institutional layering will also be more polycentric. Rather than having centralized institutions attempting to fit over broad groups of people within a geographical nation-state, entrepreneurs will, over time, discover the necessary levels of institutional rules within regions and across borders.

Another ongoing problem of institutional change in the developing world is aligning formal institutions with the underlying informal norms. Blockchain-based institutional layering—using governance approaches developed by local entrepreneurs—might better match the underlying norms, or what James C. Scott describes as metis.

New, digital, uncensorable, trustful institutional technologies open up enormous opportunities for decentralized economic development.

Because blockchain institutions are built from the bottom-up and draw on local entrepreneurial knowledge, we might see greater levels of institutional stickiness, where formal blockchain institutions better match underlying norms and therefore are embedded and longer-lasting.

Our argument risks techno-utopianism. We are confident that blockchain—or successor distributed ledger technologies not yet invented—might solve several institutional problems within the developing world. It will not, of course, solve all of them.

Nevertheless, the invention of a class of new, digital, uncensorable, trustful institutional technologies opens up enormous opportunities for decentralized economic development.

And it allows the same entrepreneurial creativity that has driven prosperity in the rich world to be turned to the causes of poverty in the developing world.

Byzantine political economy

With Sinclair Davidson and Jason Potts.

Abstract: For decades, computer science and economics have been working on the same questions in parallel. But each field has offered strikingly different answers. This paper examines the close relationship between what the study of distributed systems describes as Byzantine consensus and what the study of institutional economics describes as robust political economy. These parallels have become evident after the invention of distributed ledger technology (blockchain) via the Bitcoin cryptocurrency which provides a new technology for managing and coordinating knowledge about property rights. Blockchain is the instantiation of a new form of social infrastructure that securely decentralises property ledgers. As such it represents a shift in the role of government as a centralised property ledger.

Available at SSRN.

Blockchains and institutional layering as a new approach to economic development

With Darcy Allen.

Abstract: Since the mid-twentieth century, development economists have identified barriers to economic growth including financing a savings-investment gap, planning investments, and making lasting institutional change. Efforts to overcome these development barriers range from centralised planned intervention to decentralised entrepreneurial search. In this paper we analyse the impact of blockchain technologies on economic development. We propose that blockchains facilitate a more decentralised entrepreneurial process of economic development through institutional layering. This dynamic leads to a more permissionless, polycentric and institutionally sticky economic development process. Blockchains shift the entrepreneurial process by which development problems are defined and ameliorated through time.

Working paper available at SSRN.

Towards Crypto-friendly Public Policy

With Sinclair Davidson and Jason Potts. Published in Melanie Swan, Jason Potts, Soichiro Takagi, Frank Witte and Paolo Tasca, 2019. Blockchain Economics: Implications of Distributed Ledgers, World Scientific Publishing, Singapore, pp. 215-232.

Abstract: Distributed ledgers are institutional technologies that pose complex challenges regarding regulation and inter-jurisdictional competition. This chapter introduces ‘crypto-friendly’ public policy as a way to understand these challenges. Blockchains are relevant to public policy in at least three ways. First, they can be adopted by governments for the provision of public services. Second, many blockchain applications interact with existing regulatory frameworks and may provide new regulatory challenges. Third, they present the possibility of ‘crypto-secession’ as a form of privately provided public goods provision. The chapter applies an institutional theory of regulation to assess how blockchains effect relative institutional costs and guide public policy choices. Blockchain applications such as property rights and identity management are also considered. Finally the chapter considers the possibility of crypto-friendliness as a dimension for international regulatory competition.

Available at World Scientific.