Innovation in Regulated Industries is a Key to Social Impact
By: Robert Hacker
Tags: Paradigm Shift, Social Impact, Regulation, Network, Innovation

Credit: The European Business Review

A recent Wall Street Journal article, “Innovation Can’t Be Forced, but It Can Be Quashed”, begins:

“The Covid-19 pandemic reveals that far from living in an age of incessant technological change, we have been neglecting innovation in exactly the areas where we most need it.”

The article goes on to paraphrase the always thoughtful Peter Thiel, “innovation is now largely a digital phenomenon because bits are lightly regulated and atoms heavily regulated.” While Thiel is correct, the WSJ does him a disservice to introduce his commentary here. We would garner much more understanding of the current situation if we look at the history of the industrial revolutions since WWI, examine proven strategies for shareholder return and recognize how well we are prepared given the current strategies for research and innovation in biology, genetics, medicine, biomedical engineering and healthcare.

We are now in the early stage of what the World Economic Forum (WEF) calls the Fourth Industrial Revolution (4IR). Each industrial revolution (IR) is marked by what the seminal thinker Thomas Kuhn called a paradigm, the emergence of new technology and supporting technologies that are characterized by multiple new applications in multiple industries. The versatility of electricity marked the beginning of the 2nd IR and the advent of the computer after WWII marked the start of the 3rd IR. The adoption of both of these technologies and their derivatives were helped by the reliance on network of each technology. Networks benefit from economies of scale, which reduces the marginal cost to expand the network, and further fosters adoption.

When we look at this simple analysis, we should ask ourselves why did these technologies emerge at the particular point in history. W. Brian Arthur, the noted complexity economist, explains it simply. We needed the technology to solve an important societal problem. Electricity extended the usable hours for working, powered factories and made multiple new means of entertainment and communication possible. Computing made possible the calculations to use Claude Shannon’s Information Theory to create digital information that could be modified, stored, analyzed and shared around the world instantly. Collaboration over networks explains much of the rest of the transformation.

When we look at the 4th IR we see a paradigm emerging around artificial intelligence, with support from Internet Of Things (IOT), cyber-physical systems and cloud computing. Why did this technology emerge now given that AI was developed in the 1960s? First, it took about 40–50 years to realize that the key to successful AI was the amount of available data and not so critical the speed of computing. Second, we needed a problem with huge amounts of under-analyzed data with significant economic and social potential in the resultant analysis. Where o where today is such data? Answer: genetics, personal health data and medicine. All of this data was made possible by combining electricity and Shannon’s insight about digital bits. Today, we increasingly see mention of exabytes of data, quickly replacing petabytes (and gigabytes and megabytes). These enormous amounts of data were rarely mentioned even five years ago, but cloud computing and database technologies make them manageable today. To answer Matt Ridley, the author of the WSJ article, we needed the technology and innovation to manage large datasets and to manipulate the component structures of biology, chemistry and genetics as combinatorial tinker toys, before we could use this new technology to tackle health problems such as Covid-19. In a report released May 2020, The Bio Revolution, Mckinsey estimates the opportunities in biology alone to represent an additional $1.2 trillion by 2040.

The question one could ask is why did we develop Facebook, Airbnb, Twitter … and not put all that investment in technology such as CRISPR gene editing or computational–experimental drug combination prediction and testing (DCPT). One answer is shareholders. According to PWC, the international consulting firm, since 2000 corporate research spending has far exceeded U.S. government spending. Today corporate research amounts to approximately $780 billion or six times government research spending. This research is targeted toward incremental innovations in order produce the highest returns for the lowest risk to shareholder investment. Facebook, Airbnb, Twitter and hundreds of other new companies all make use of network-based platforms or single and dual-sided marketplaces. The venture capital firm nFx studied the returns of technology companies. 70% of the total market capitalization of technology companies is network-based business models. Network-based business models are attractive because there is little marginal cost to scale, perhaps only one-time customer acquisition cost in the non-organic growth models. Medical research, on the other hand, historically required highly skilled researchers resulting in a significant marginal cost each year and expensive multi-year clinical trials.

“We needed the technology and innovation to manage large datasets and to manipulate the components of biology, chemistry and genetics as combinatorial tinker toys, before we could tackle health problems such as Covid-19.”

The other answer for why we did not invest in medical research, and instead chose the network-based business models, is timing. As Arthur makes clear, technology emerges for a purpose — to solve a particular problem(s). Much of the technology required for advanced medical research was until recently still in the developmental phase with specificity and reproducibility issues. For example, the CRISPR technology was only commercially available as recently as 2013. Applications of AI to medical research were slowed by database and technology issues. Cloud computing and the necessary tools were only really commercialized, for example by Google, in 2011. Much of the technology is very recent and to expect it to be focused on black swan events such as a pandemic so quickly is wildly optimistic.

The more important question is, now with what we learned from Covid-19, will the medical researchers target pandemics with their new tools and will the environmental scientists also get the funding to prevent related health issues. What we are really asking is whether the corporations can better balance shareholder returns and social impact. That is the big question and the WEF is encouraging corporations to increasingly focus on social impact. Without such a new focus, I think WEF is worried that the capitalist system will come under widespread public attack.

If we wanted to hedge our bets on whether corporations will invest in social impact, especially in medicine and the environment, we have some choices. More government research spending paid for by less defense spending might be an approach. Let’s just move ten percent of the U.S. defense budget, approximately $72 billion, to research initiatives. This amount would represent roughly a fifty percent increase in annual government research spending and we could earmark it for medical and environmental research (or maybe space research if we need to evacuate earth).

Another point to realize is that the easy fixes were done in the 3rdIR. All the unregulated industries were significantly disrupted by the digital revolution, the focus on real-time customer experience and constant connectivity. For corporations to find real growth opportunities today they will need to direct the new paradigm technologies toward disrupting regulated industries such as healthcare, education, construction and airlines. This is where regulation plays a significant role, having protected inefficient industries and permitted participants to earn excessive returns. Perhaps this explains why Amazon, Microsoft and Google, to name a few, are all focused on new opportunities in healthcare and education. Not important that one understand so well the industry, brute force AI and cloud computing will create the opportunities and the next big revenue growth. Does not sound like social impact focused strategy, but the results may be the same.

As I tell my students, I am a “capitalist dog”. I would like to see capitalism preserved and for corporations to better balance shareholder returns and the required social impact. How to do this I explained in more detail in this article, “The Time for Social Innovation is Now — Three Strategic Alternatives”. Of course, corporations could pursue the three strategic alternatives and we could still move billions from defense spending to research.