Reprinted from the Independent Institute
Experience is the best teacher.
So, while my first introduction to the idea of entry barriers was undoubtedly as an undergraduate student, my first encounter with them was six months into my first job after college.
I was working as an assistant project manager at an eight-month-old tech startup. It was much more than a ramshackle operation, as one might picture in someone’s garage—though some of the biggest firms of all time had their start that way. We hovered around forty employees and had secured tens of millions in funding. I mention these facts only to establish that it’s not merely mom-and-pops which run aground on the entry barriers I’ll be describing.
The notion of entry barriers is a concept subject to much confusion, though it needn’t be. Start by drawing two distinctions. There are barriers arising “naturally,” as it were, in markets. Then there are those created by government activity. Of these, barriers come in the form of special privileges from government—sometimes “direct,” at other times “indirect.” More on these in a moment.
“Natural” entry barriers include things like brand loyalty or economies of scale that make it more costly for a new entrant to compete with incumbents. There is nothing “special” about “natural” barriers. They arise when one seller is particularly efficient at satisfying consumer preferences. They exist in the same way that Novak Djokovic’s tennis skill is an entry barrier to former Division III tennis players, such as myself, ascending to the world number one ranking. Barriers arising naturally in markets demonstrate the presence of healthy and skillful market competitors. Entering the market may be “barred” in some sense, but costs are a barrier to every action. Natural entry barriers are just a special case of this general principle.
Government entry barriers are “artificial” in the sense that they do not arise from some producer’s superior productive efficiency. Direct grants of special privilege are easy to detect. Internet service providers are a classic example. Municipal governments typically dispense licenses that limit the number of ISPs in a region. Government intentionally and directly bestows the right to enter on some firms and bars others.
By contrast, indirect grants of special privilege are a bit more difficult to see, but they’re probably all the more ubiquitous. Two quick examples. The Americans with Disabilities Act required (among other things) that businesses install handicap-accessible stalls in their restrooms. Wal-Mart easily swallows the costs associated with this requirement. Expanding restrooms by a few feet is a drop in the bucket as a percentage of their total real estate costs. Mom-and-pops, however, may find their costs have increased by ten percent. This ADA stipulation disproportionately harms small businesses. Indirectly, government has conferred special rights on Wal-Mart.
In Europe, the General Data Protection Regulation (GDPR) has hampered investment in new digital firms. It’s hardly necessary to spell out that Facebook, Twitter, Google, and the gang benefit from this hedge.
This brings me back to my own rude encounter with indirect grants of special privilege. I was re-reading an email for the fifth time, making sure I’d grasped its terse contents. For the past 6 months, I’ve been helping our startup achieve compliance with the Children’s Online Privacy Protection Act (COPPA). I’d meticulously take screenshots of every page of our site and send them to a group of lawyers who specialized in digital compliance. They’d respond with requirements and recommendations that I’d communicate to our developers.
As with so many other indirect entry barriers, COPPA seemingly has the best of intentions: protect children under 13 while they use the internet. It’s possible COPPA achieves its goal, but I’m no expert.
What I did learn with utter clarity, however, is that even the most well-intentioned public policy has ripple effects that policymakers are not always capable of anticipating. I was (re) reading the email from our legal counsel based in D.C. The very kind lawyer I’d been corresponding with was reluctant to inform me that Congress had just passed a significant overhaul of COPPA. Our hard work over the last six months was in vain. We’d be starting over.
Except we never did.
At that moment, our CEO decided we simply wouldn’t enter the market for children 13 and under. This decision was particularly ironic because I’ve never encountered a digital product that would have been safer for children than the one we were offering. Privacy and security were the differentiating hallmarks of our product. Nonetheless, the costliness of compliance foreclosed our entry. Regrouping, the CEO announced we “might” service that market segment later when we were bigger and had more resources.
My toil of six months was flushed away in an instant. The hard work of a dozen developers was likewise in vain. And it would be easy to focus on that “wasted” labor, but mistakes—errors—happen in markets and in life all the time. They’re unavoidable. No, here, the true cost was that the so-called Tech Giants lived to see another day, as an impudent upstart with aims of nipping at their heels was kicked to the curb by government’s visible
How long did it take (say) Facebook to become compliant with the new COPPA regulations? If I had to guess, I’d say two hours. Within seconds of Congress passing the amendments, Facebook leadership was undoubtedly abreast of these developments. Facebook’s large internal legal team quickly conferenced with a few of their world-class engineers, who summarily made the necessary changes.
Even before the malaise generated by the cocktail of COVID, COVID policy, and money-printing, it was well-acknowledged that the U.S. economy had grown increasingly sclerotic. While a blip in the grand scheme of things, it’s a trend that invites more and urgent research, as a consensus on its causes does not seem to be forthcoming. Research must reveal what share of the U.S. economy’s decreasing dynamism is due to a proliferation of indirect grants of special privilege.
What I know, though, without any sophisticated econometrics, is that my own encounter with indirect grants of special privilege is not one I wish to repeat any time soon—or ever.