Innovation and Competition in the Digital Economy

1. Innovation and Competitionin the Digital Economy Joseph E. Stiglitz Paris October 1, 2007

2. Dramatic Changes in digital technologies • Lowering communication costs • 50 percent compounded annual decline in telecommunication costs in the 1990s • Fiber optic glut during the Internet Bubble slashed telecom cost • Scanners convert data to image file - 160 pages per minute. • Improvements in the ability to gather, process, and disseminate information

3. With dramatic implications for economic efficiency • Direct effects • Efficiency with which resources get allocated • Imperfect information as a barrier to economic efficiency • Indirect effects • Competitiveness of economy • Especially price variables • Still large extent of information imperfection from “qualitative” variables

4. Impacts even in (especially in) developing countries • Market imperfections (based on information imperfections) greater • Greater barriers to creating effective telecommunication system prior to cellular technologies • Reduced “economic distance” between developed and developing countries • Increased access to knowledge • What separates developed and less developed countries is not just disparity in resources but disparity in knowledge • Reduced impacts of other infrastructure gaps

5. Large part of basis of success of India • Growing at 8-9% in recent years • 5-6% for over a quarter century • Increasing role in China’s success • Growing at 10% for three decades

6. But the world is not flat… • And in many ways is getting less flat • Partially based on “unfair” international rules • Partially based on ability to take advantage of new technologies

7. For perhaps the first time in history • The possibility of global monopoly in technologies that are at the center of the economy • PC operating systems • Already demonstrated willingness to use (abuse) market power • has extended that power to new areas • Internet explorer • Media player • And could extend it further

8. Key questions: • Will competition regulation enhance or suppress innovation? • One view holds that unbridled competition is best way to induce innovation • Other view that if unbridled competition results in market power, innovation will be suppressed • What is best way of promoting innovation and competition? • What is appropriate intellectual property regime? • Should there be standard setting policies?

9. Lessons from Recent History • There are markedly different prices in different markets • Mexico, U.S., India • Related more to the nature of competition in these markets • US has many firms, but only a few competing • Harder to create competition than one thought • Once competition has been broken down, hard to restore

10. Fundamental problems • R & D entails large fixed, sunk costs • There are large network externalities • Also associated with interfaces (applications for PC operating systems) • And learning • Advantages of standards • But market does not necessarily arrive at an efficient standard on its own • Market may not even arrive at any standard on its own

11. Implications • Tipping phenomenon—once firm gets critical fraction of market share, can become dominant • Once dominant, hard to introduce or restore competition • Once dominant, can leverage market power into other markets • Ability to abuse market power enhanced by innovations in marketing • Bundling—hard to compete against a zero market price • Non-linear pricing • Especially easy to use in markets with low (zero) marginal costs

12. Competition and Innovation • Monopolies have insufficient incentives to innovate • lower scale of production • adverse impact on prior invested capital • Have ability to maintain monopoly position • Schumpeter was wrong (succession of monopolies) • Doctrine that all that is required is potential competition is wrong • Contestability doctrine held that even with increasing returns to scale potential competition could ensure efficient outcomes • Contestability doctrine was shown to be wrong if there are any sunk costs • R & D entails sunk costs • Ability to abuse monopoly position vitiates innovative incentives of potential competitors • Examples of Netscape, Realnetworks

13. Intellectual Property • Only one part of society’s innovative system • And not the most important part • At base is basic research • Most of which is publicly supported • Poorly designed IP regime can reduce innovation • Knowledge is the most important input into research • By raising price of knowledge, reduces innovation • IP can lead to monopolies • Monopolies have less incentive to do research • Monopolies can suppress other’s research • Patent thicket increasingly viewed as barrier to innovation • Blackberry example

14. IP • Interferes with economic efficiency • Marginal cost of using knowledge is zero • So restricting usage is inefficient • Worse: creates monopoly power • Static inefficiency only justified by dynamic gains • But in poorly designed IPR systems dynamic benefits may be less than static costs • Dynamic benefits may even be negative

15. Lessons • IPR creates monopoly power • Monopoly power can easily be abused • Need to restrict abusive practices • IPR is “man-made”—balances benefits and costs • Large number of dimensions (duration, scope, restrictions, disclosure requirements)—need to adjust to maximize social benefits • Competition will not arise on its own • Political pressures to allow monopolistic practices

16. Need to have multiple competitive regulatory authorities • Not just telecom agency • But maintaining competition may not be easy • Structural separation may be necessary • Difficulty in enforcing, e.g. non-discrimination regulations • May help align incentives • Limitations on IPR • May actually enhance innovation

17. Multiple reforms in IPR • Necessary to maintain innovation • Better enforcement of disclosure requirements • Strengthening novelty standard • Limiting scope/breadth • “liability system”—compensation for trespass • Better systems of “opposition” • Recognizing that IPR regime appropriate for software differs from drugs, entertainment • Especial care in promoting open source movement

18. Standards • Can bring enormous benefits • But there is a risk of settling on the wrong standard • And difficult to displace standard once established • Weighing of public and private failures • Huge rents generated by owner of pivotal standards • Large distributive consequences • Attempts at excessive rent extraction give rise to incentives for standard proliferation

19. Telecom: Living up to its potential • Promoting competition—diverse products, low prices • Promoting innovation—one of sectors with highest Innovation potential • Promoting equality—limiting growth of the digital divide Will not happen on its own

20. Will require • Strong competition policies • Universal access policies • Well designed intellectual property rights PART OF BALANCED REGULATORY SYSTEM—RECOGNIZING LIMITATIONS OF MARKETS AND GOVERNMENT PART OF WELL FUNCTIONING MARKET ECONOMY (ACCESS TO FINANCE) PART OF BALANCED INNOVATION SYSTEM

21. AT FOUNDATION OF INNOVATION SYSTEM • ADVANCED EDUCATION AND RESEARCH PROGRAMS • FUNDED BY GOVERNMENT AND INDUSTRY • WITH A FOCUS ON ADDRESSING MAJOR PROBLEMS OF ECONOMIES AND SOCIETY • Not just maximizing profits—which may be more focused on exploiting market power • Markets often have too short a time horizon • WELL SITUATED TO PUT NEW DISCOVERIES INTO PRACTICE • Basic research on browser supported by U.S. government • First widely marketed application by private sector (Netscape) • Market position stolen by Microsoft’s abusive use of control of operating system

22. In manufacturing, increases in France’s productivity per hour has been much larger than in U.S. • Technical proficiency in telecom will be critical for coming decades • U.S. has dominated in certain core programs/areas • Question: why? • Question: can government intervention, e.g. mandating Linux on government computers, offset these market forces? • Question: should government do this? • But many European countries have established strong positions in niche areas

23. This institution and this new chair can help ensure both the technical capacities and the policy frameworks which will make it more likely that France will have a dynamic, competitive telecom sector from which all will benefit: • France will benefit • But so too will the entire world.