1. Innovation and Competition in 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 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. Technical proficiency in telecom will be critical for coming decades
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.