Along with colleagues at the Mercatus Center at George Mason University, I am releasing two major new reports today dealing with the regulation of the sharing economy. The first report is a 20-page filing to the Federal Trade Commission that we are submitting to the agency for its upcoming June 9th workshop on “The “Sharing” Economy: Issues Facing Platforms, Participants, and Regulators.” We have been invited to participate in that event and I will be speaking on the fourth panel of the workshop. The filing I am submitting today for that workshop was co-authored with my Mercatus colleagues Christopher Koopman and Matt Mitchell.

The second report we are releasing today is a new 47-page working paper entitled, “How the Internet, the Sharing Economy, and Reputational Feedback Mechanisms Solve the ‘Lemons Problem.'” This study was co-authored with my Mercatus colleagues Christopher Koopman, Anne Hobson, and Chris Kuiper.

I will summarize each report briefly here.

In our new filing to the FTC, we address the five questions the Commission set forth in its workshop annoucement. Those five questions are as follows:

• How can state and local regulators meet legitimate regulatory goals (such as protecting consumers, and promoting public health and safety) in connection with their oversight of sharing economy platforms and business models, without also restraining competition or hindering innovation?
• How have sharing economy platforms affected competition, innovation, consumer choice, and platform participants in the sectors in which they operate? How might they in the future?
• What consumer protection issues—including privacy and data security, online reviews and disclosures, and claims about earnings and costs—do these platforms raise, and who is responsible for addressing these issues?
• What particular concerns or issues do sharing economy transactions raise regarding the protection of platform participants? What responsibility does a sharing economy platform bear for consumer injury arising from transactions undertaken through the platform?
• How effective are reputation systems and other trust mechanisms, such as the vetting of sellers, insurance coverage, or complaint procedures, in encouraging consumers and suppliers to do business on sharing economy platforms?

We provide detailed answers to each of these questions as well as one additional major question that was not posed by the Commission in its workshop notice but which is, no doubt, on the minds of many at the agency and outside it: What should the FTC do about state and local barriers to entry and innovation that might be thwarting the growth of the sharing economy? (I blogged about that issue here a couple of weeks ago and our filing includes that discussion.)

Please take a look at our filing for detailed answers to each of these questions. (Incidentally, our filing is an extension of an earlier working paper that Koopman, Mitchell, and I released late last year on “The Sharing Economy and Consumer Protection Regulation: The Case for Policy Change.”) But, to briefly highlight the thrust of our argument, here’s a passage from our new filing:

As the debate surrounding the sharing economy moves forward, policymakers must keep in mind that merely because regulations were once justified on the grounds of consumer protection does not mean they accomplished those goals or that they are still needed today. Even well-intentioned policies must be judged against real-world evidence. Unfortunately, the evidence shows that many traditional consumer protection regulations hurt consumers; in the words of New York Attorney General Eric Schneiderman, they are often “cumbersome, and some are just plain protectionist.” Markets, competition, reputational systems, and ongoing innovation often solve problems better than regulation when they are given a chance to do so. There are two reasons for this. First, market imperfections create powerful profit opportunities for entrepreneurs who are able to find ways to correct them. Second, regulatory solutions too often undermine competition and lock in inefficient business models.

We continue on to explain exactly why that is the case, while also offering some constructive solutions to other issues that are on the minds of regulators.

Meanwhile, the new working paper we are releasing today provides much greater detail on the fifth of the five questions the FTC posed in its workshop notice regarding reputation systems and other trust mechanisms. Here is the abstract from the paper:

This paper argues that the sharing economy—through the use of the Internet and real time reputational feedback mechanisms—is providing a solution to the lemons problem that many regulators have spent decades attempting to overcome. Section I provides an overview of the sharing economy and traces its rapid growth. Section II revisits the lemons theory as well as the various regulatory solutions proposed to deal with the problem of asymmetric information. Section III discusses the relationship between reputation and trust and analyzes how reputational incentives affect commercial interactions. Section IV discusses how information asymmetries were addressed in the pre-Internet era. It also discusses how the evolution of both the Internet and information systems (especially the reputational feedback mechanisms of the sharing economy) addresses the lemons problem. Section V explains how these new realities affect public policy and concludes that asymmetric information is not a legitimate rationale for policy intervention in light of technological changes. We also argue that continued use of this rationale to regulate in the name of consumer protection might, in fact, make consumers worse off. This has ramifications for the current debate over regulation of the sharing economy.

We believe that our research makes it clear “how the sharing economy relies upon—and has helped spur the growth of—sophisticated reputational feedback mechanisms that facilitate online trust and commerce, overcoming many of the information asymmetries that seemed intractable… just a generation ago. In combination with online review services and other information-sharing technologies enabled by the Internet,” we conclude, “these reputational tools can help create more effective, and largely self-regulating, markets that provide more information to more individuals than ever before.”

We look forward to continuing engagement with officials at the FTC and other policymakers at the federal, state, and even international level on these issues. We hope our research will help legislators and regulators find sensible ways to adjust policy for the sharing economy so as not to derail the sort of “permissionless innovation” that has thus far powered this exciting sector and produced the many pro-consumer benefits flowing from it. Check out our filing and new paper for more details.

by Larry Downes and Geoffrey A. Manne

Now that the election is over, the Federal Communications Commission is returning to the important but painfully slow business of updating its spectrum management policies for the 21st century. That includes a process the agency started in September to formalize its dangerously unstructured role in reviewing mergers and other large transactions in the communications industry.

This followed growing concern about “mission creep” at the FCC, which, in deals such as those between Comcast and NBCUniversal, AT&T and T-Mobile USA, and Verizon Wireless and SpectrumCo, has repeatedly been caught with its thumb on the scales of what is supposed to be a balance between private markets and what the Communications Act refers to as the “public interest.”

Commission reviews of private transactions are only growing more common—and more problematic. The mobile revolution is severely testing the FCC’s increasingly anachronistic approach to assigning licenses for radio frequencies in the first place, putting pressure on carriers to use mergers and other secondary market deals to obtain the bandwidth needed to satisfy exploding customer demand.

While the Department of Justice reviews these transactions under antitrust law, the FCC has the final say on the transfer of any and all spectrum licenses. Increasingly, the agency is using that limited authority to restructure communications markets, beltway-style, elevating the appearance of increased competition over the substance of an increasingly dynamic, consumer-driven mobile market.

Given the very different speeds at which Silicon Valley and Washington operate, the expanding scope of FCC intervention is increasingly doing more harm than good.

Deteriorating Track Record

We’re trapped in a vicious cycle: the commission’s mismanagement of the public airwaves is creating more opportunities for the agency to insert itself into the internet ecosystem, largely to fix problems caused by the FCC in the first place. That is happening despite the fact that Congress clearly and precisely circumscribed the agency’s authority here, a key reason the internet has blossomed while heavily regulated over-the-air broadcasting and wireline telephone fade into history.

Desperate for continued relevance, the FCC can’t resist the temptation to tinker with one of the only segments of the economy that is still growing and investing. The agency, for example, fretted over Comcast’s merger with NBCUniversal for 10 months, approving it only after imposing a 30-page list of conditions, including details about which channels had to be offered in which cable packages.

Regulating-by-merger-condition has become a popular sport at the FCC, one with dangerous consequences. While it conveniently allows the agency to get around the problem of intervening where it has no authority, the result is a regulatory crazy quilt with different rules applying to different companies in different markets. Consumers, the supposed beneficiaries of this micromanagement, cannot be expected to understand the resulting chaos.

For example, Comcast also agreed to abide by an enhanced set of “net neutrality” rules even if, as appears likely, a federal appeals court throws out the FCC’s 2010 industry-wide rulemaking for exceeding the agency’s jurisdiction. As with all voluntary concessions, Comcast’s acquiescence isn’t reviewable in court.

The FCC made an even bigger hash in its review of AT&T’s proposed merger with T-Mobile. Once it became clear that the FCC was bowing to political pressure to reject the deal, the companies pulled their applications for license transfers to focus on winning over the Department of Justice first. But FCC Chairman Julius Genachowski, determined to have his say, simply released an uncirculated draft of the agency’s analysis of the deal anyway.

The report found that the combination, as initially proposed, would control too much spectrum in too many local markets. But that was only after the formula, known as the “spectrum screen,” was manipulated to reduce substantially the amount of frequency included in the denominator. Hidden in a footnote, the report noted cryptically that the reduction was being made (and explained) in an unrelated order yet to be published.

When the other order was released months later, however, it made no mention of the change. It never actually happened. With the T-Mobile deal off the table, apparently, the chairman found it more expedient to leave the screen as it was, at least until further gerrymandering proved useful. Unwittingly, Genachowski had exposed his hand in rigging a supposedly objective test applied by a supposedly independent agency.

Leave it to the Experts

This amateurish behavior, unfortunately, is increasingly the norm at the FCC. Politics aside, part of the problem is that while federal antitrust regulators enforce statutes under a long line of interpretive case law, the FCC’s review of license transfers is governed by an undefined and largely untested public interest standard.

Now the commission is asking interested parties how, if at all, it needs to formalize its transaction review process, particularly the spectrum screen calculation it blatantly manipulated in the AT&T/T-Mobile review. It’s even asking whether it should re-impose a rigid cap on the amount of spectrum any one carrier can license, a bludgeon of a regulatory tool the agency wisely abandoned in 2003.

We have a better idea. Do away with easily forged formulae and proxies with no scientific relevance. Instead, review transactions in the broader context of a dynamic broadband ecosystem that is disciplined not only by inter-carrier competition, but increasingly by device makers, operating system providers, app makers and ultimately by consumers.

Every user with an iPhone 5 knows perfectly well how complex and competitive the mobile marketplace has become. It’s now time for the government to abandon its 19th century toolkit and look at actual data—data that the FCC already collects and dutifully reports, then ignores when political expediency beckons.

Thanks to the FCC’s endemic misadventures in spectrum management, we can expect more, not fewer, mergers—necessitating more, not fewer, commission reviews. Rather than expanding the agency’s unstructured approach to transaction reviews, we should be reining it in. As the FCC embarks on its analysis of T-Mobile’s takeover of MetroPCS and Sprint’s acquisition by SoftBank, it’s time to put an end to dangerous mission creep at the FCC.

That, at least, would better serve the public interest.

(Reprinted, with permission, from Bloomberg BNA Daily Report for Executives, Dec. 6, 2012.  Our recent paper on FCC transaction review can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2163169.)

The Internet is massive. That’s the ‘no-duh’ statement of the year, right?  But seriously, the sheer volume of transactions (both economic and non-economic) is simply staggering.  Consider a few factoids to give you a flavor of just how much is going on out there:

• In 2006, Internet users in the United States viewed an average of 120.5 Web pages each day.
• There are over 1.4 million new blog posts every day.
• Social networking giant Facebook reports that each month, its over 300 million users upload more than 2 billion photos, 14 million videos, and create over 3 million events. More than 2 billion pieces of content (web links, news stories, blog posts, notes, photos, etc.) are shared each week. There are also roughly 45 million active user groups on the site.
• YouTube reports that 20 hours of video are uploaded to the site every minute.
• Amazon reported that on December 15, 2008, 6.3 million items were ordered worldwide, a rate of 72.9 items per second.
• Every six weeks, there are 10 million edits made to Wikipedia.

Now, let’s think about how some of our lawmakers and media personalities talk about the Internet.  If we were to judge the Internet based upon the daily headlines in various media outlets or from the titles of various Congressional or regulatory agency hearings, then we’d be led to believe that the Internet is a scary, dangerous place. That ‘s especially the case when it comes to concerns about online privacy and child safety. Everywhere you turn there’s a bogeyman story about the supposed dangers of cyberspace.

But let’s go back to the numbers. While I certainly understand the concerns many folks have about their personal privacy or their child’s safety online, the fact is the vast majority of online transactions that take place online each and every second of the day are of an entirely harmless, even socially beneficial nature.  I refer to this disconnect as the “problem of proportionality” in debates about online safety and privacy. People are not just making mountains out of molehills, in many cases they are just making the molehills up or blowing them massively out of proportion.

Go back to those Facebook numbers, for example. 300 million users uploading 2 billion pieces of content each week, plus 45 million user groups.  Now, how many “incidents” do you hear about in the course of an entire year involving privacy and child safety on Facebook? A couple? A dozen?  I doubt it’s that many, but for the sake of argument, let’s be preposterous and say the number of incidents is 10,000.  Doing some quick math: 10,000 “incidents” divided by 2 billion pieces of content shared each week = 0.001%   In other words, there would need to be hundreds of thousands of privacy or child safety “incidents” taking place on Facebook each week before one could legitimately claim the trend was statistically significant in proportion to the total volume of transactions.

Of course, there’s no way to be scientific about this since I can’t crunch the numbers to get an exact calculation for Facebook or the entire Internet since it’s hard to even define or collect info about online “incidents.” And this is not to say there are never any incidents online where some harm might come to an individual or a child.  Defining “harm” can be contentious, however, especially when it comes to what I regard as the conjectural theories about advertising or provocative media content “harming” us or our kids.

Of course, others could claim that the sheer volume of information that we put online about ourselves is problematic for a variety of other reasons. The best argument about potential harm coming of all this information being online is that the sheer volume of data sharing and collection opens up the door to identify theft, or that some government agencies could get their hands on it and use it to do nasty stuff to us.  That first problem can be a legitimate one, and deserves more attention and greater consumer education. But that latter problem should be addressed by putting more constraints on our government(s), not by imposing more regulations on the Internet. Government powers should be tightly limited when it comes to monitoring the habits of websurfers or collecting information about them.

Nonetheless, it is my contention that an infinitesimal percentage of all daily online transactions and interactions involve serious privacy violations or harm to children.  Until they can prove otherwise, we need to demand that our policymakers and folks in the press put these issues into some perspective before they jump to conclusion about online life.  Enough of the fear-mongering and techno-panics!