The Invisible Hand, the Regulatory Touch or the Platform’s Iron Grip?

Aluma Zernik, Harvard Law School

-- The “invisible hand” has become an icon for an economic philosophy which assumes that a laissez-faire governmental policy will result in optimal social and financial outcomes as market forces will drive a socially efficient equilibrium. Over the years and since the New Deal, this approach has been in tension with another philosophy, which emphasizes the role of regulation in correcting market failures that inhibit markets from functioning smoothly. A third approach to market regulation—that of the multi-sided platform, is discussed in my recent paper: “The Invisible Hand, the Regulatory Touch or the Platform’s Iron Grip?”.

Multi-sided platforms are designed specifically to control and craft parties’ underlying transactions. In the modern era, data-savvy platforms collect information on every participant and transaction; control entrance, information flow, and competition design; assist in searching and matching; set the contractual terms (and sometimes even price) of a finalized transaction; allocate risk between parties; and are often involved in enforcing the transaction or resolving disputes. Thus, refraining from government intervention in markets leaves the market to be governed not by the invisible hand of competition, but by iron grip of the platform that closely monitors and designs every aspect of its underlying parties’ interactions.

Platforms are drive by a profit-maximizing goal, but profits may, in turn, be influenced by trust, reputation, growth, and efficiency, which are often in line with regulatory goals. When a platform’s goals align with those of “benevolent” regulators, the platform can often supersede government regulators. Thus, rather than asking whether Uber or its drivers should be regulated as a taxi company, or whether Airbnb should be regulated as a hotel, policymakers should instead question if Uber can replace the Department of Transportation and Airbnb the National Tourism Office.

Unlike public regulators, these potential private regulators have significant resources, are data-driven and are not limited in their ability to conduct market research and experimentation, enabling them to rapidly adopt and amend policy changes. On the other hand, policies adopted by these platforms may not address risks or quality concerns that are less salient to the average consumer and therefore have less impact on the platform’s reputation. Furthermore, they may be indifferent to externalities, fairness and distribution concerns, they have limited obligations of transparency and due process, and may have an interest in designing competition in a manner that increases their market share and profit margins. Thus, recognizing factors that influence the alignment of platforms’ interests with those of the general public is crucial in understanding whether platforms are expected to be hyper-efficient private regulators, or conflicted actors which will design their underlying markets to reduce public welfare.

The paper points to two central forces that can align platforms’ interests with those of public welfare: transparency, and competition. Reputation is a significant driver of participation on the platform and its popularity. Reputation, in turn, is driven by salience and transparency on the platform. This is true for whether users can perceive and gain information about features offered by the platform, as well as for whether externalities of the platform and its social and distributional outcomes are salient to the public as a whole, driving platforms to internalize such considerations. Thus, consumers should have access to information about platforms’ design and actions, which may be created through transparency of the platform’s algorithms and outcomes.

But trust and reputation are efficient catalysers only when platforms are subject to competitive pressures, on all sides of the platform. As network effects lead markets to consolidate, and if platforms adopt policies that lock in users, limiting their use of other platforms or off-platform alternatives, their alignment with the public interest is likely to wane. Additionally, competition has to be strong on all sides of the platform, or policies will cater to the interests of one party over the other, so that regulatory arbitrage may lead to a regulatory race to the bottom, inefficiently balancing the interests of one side of the market over others.

Thus, the initial focus of regulators should be to practices that may curb competition between platforms, and to those features that are less transparent and salient to participants and the public as a whole.

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