Strangling Innovation: Tesla Versus 'Rent Seekers'

The greatest number of jobs is created when startups create a new market -- one where the product or service never existed before or is radically more convenient. Yet this is where startups will run into anti-innovation opponents they may not expect. These opponents have their own name -- "rent seekers" -- the landlords of the status-quo. Recently, the New York and North Carolina legislatures considered a new law written by auto dealer lobbyists that would make it illegal for Tesla to sell cars directly to consumers. This got me thinking about the legal obstacles that face innovators with new business models. Examples of startups challenging the status quo include: Lyft, Square, Uber, Airbnb, SpaceX, Zillow, Bitcoin, LegalZoom, food trucks, charter schools, and massively open online courses. Past examples of startups that succeeded in redefining current industries include Craigslist, Netflix, Amazon, Ebay and Paypal. Rent seekers are individuals or organizations that have succeeded with existing business models and look to the government and regulators as their first line of defense against innovative competition.

They use government regulation and lawsuits to keep out new entrants with more innovative business models. They use every argument from public safety to lack of quality or loss of jobs to lobby against the new entrants. Rent seekers spend money to increase their share of an existing market instead of creating new products or markets. The key idea is that rent seeking behavior creates nothing of value. These barriers to new innovative entrants are called economic rent. Examples of economic rent include state automobile franchise laws, taxi medallion laws, limits on charter schools, auto, steel or sugar tariffs, patent trolls, bribery of government officials, corruption and regulatory capture. They're all part of the same pattern - they add no value to the economy and prevent innovation from reaching the consumer. Not all government regulation is rent or rent seeking. Not all economic rents are bad. Patents for example, provide protection for a limited time only, to allow businesses to recoup R&D expenses as well as make a profit that would often not be possible if completely free competition were allowed immediately upon a products' release.

But patent trolls emerged as rent seekers by using patents as legalized extortion of companies. How do Rent Seekers win, Instead of offering better products or better service at lower prices, rent seekers hire lawyers and lobbyists to influence politicians and regulators to pass laws, write regulations and collect taxes that block competition. The process of getting the government to give out these favors is rent-seeking. Rent seeking lobbyists go directly to legislative bodies (Congress, State Legislatures, City Councils) to persuade government officials to enact laws and regulations in exchange for campaign contributions, appeasing influential voting blocks or future jobs in the regulated industry. They also use the courts to tie up and exhaust a startups limited financial resources. PayPal consistently walked a fine line with regulators. Early on the company shutdown their commercial banking operation to avoid being labeled as a commercial bank and burdened by banks' federal regulations. PayPal worried that complying with state-by-state laws for money transmission would also be too burdensome for a startup so they first tried to be classified as a chartered trust company to provide a benign regulatory cover, but failed.

As the company grew larger, incumbent banks forced PayPal to register in each state. The banks lobbied regulators in Louisiana, New York, California, and Idaho and soon they were issuing injunctions forcing PayPal to delay their IPO. Ironically, once PayPal complied with state regulations by registering as a "money transmitter" on a state-by-state basis, it created a barrier to entry for future new entrants. The U.S. auto industry is a textbook case of rent seeking behavior. In 1981 unable to compete with the quality and price of Japanese cars, the domestic car companies convinced the U.S. 5 billion for cars. Japan overcame these barriers by using their import quotas to ship high-end, high-margin luxury cars, establishing manufacturing plants in the U.S. In contrast, U.S. car manufacturers raised prices, pocketed the profits, bought off the unions with unsustainable contracts, ran inefficient factories and stopped innovating. According to a Gallup poll, American consumers view car salesman as dead last in honesty and ethics.

In these states it appears innovation be damned if it gets in the way of a rent seeker with a good lobbyist. Much like PayPal, it's likely that after forcing Tesla to win these state-by-state battles, the auto dealers will have found that they dealt themselves the losing hand. Rent seeking strangles innovation in its crib. When companies are protected from competition, they have little incentive to cut costs or to pay attention to changing customer needs. The resources invested in rent seeking are a form of economic waste and reduce the wealth of the overall economy. Startups, investors and the public have done a poor job of calling out the politicians and regulators who use the words "innovation means jobs" while supporting rent seekers. What does this mean for startups, In an existing market it's clear who your competitors are. You compete for customers on performance, ease of use, or price. As a result disrupting the status quo in regulated market can be costly.