Standards and innovation

Standards have become a part of our daily lives. If we look around us, standards are present in the way we live, as we go about our respective professions, the products and services we use. In particular, the standards referred are the rules intended to codify attributes of both goods and the provision of services. These output attributes could involve providing information, specifications; mainly physical characteristics and quality, technology, safety and compatibility.

In Economics, a system of standards will influence decision making of market agents, their behavior and how markets allocate a given output. An economic consideration for the influence of standards leads us to notice the following: First, many standards do provide benefits in markets wherever present. These benefits are non-congestible (that is, do not diminish as standards are used) and basically non-exclusionary (anybody can take advantage of a given standard and exclusion can possibly take the form of compliance costs). Second, some standards are implemented as a solution to market failures (these are shortcomings resulting from a pure market allocation) which otherwise will not be corrected. Standards in this regard can also be seen to represent the cheaper way addressing these market failures. Finally, standards can be seen as providing incentives (or disincentives) toward adopting a particular way of behavior. Vehicular emission standards, for instance, encourage owners to maintain their cars better. It will be standards as incentives which make these a powerful tool in inducing innovations. The creation of innovations can be seen either as a response or a way of complying to a standard; either way, the resulting innovations will dictate the future technological path.

Classification of standards can be made according to broad economic effects. One type involves compatibility and interfaces; usually present in output used within networks. Outputs in these networked markets have the peculiarity of generating more benefits as the number of users/consumers increases. Compatibility and interfacing standards are a way of maximizing network effects and minimizing switching costs of members from alternative networks. Implementing standards of this nature will also reduce the risks for innovators knowing that their creations can interface and are compatible with existing network components. Intended users find comfort from the knowledge that what they are adopting can be easily integrated into existing networks, creating a critical mass or pool of users.

Standards falling within this type are widely present into video formats, telecommunications and information technologies. One can only surmise that if these standards were present during the introduction of laser discs, the lock-in that resulted from adoption (and the expense) could have been avoided. Another type of standards specifies minimum quality and safety considerations. Standards of these nature are grouped together for both are intended to provide information to (mainly) consumers about what they are buying and (partly) to vendors for compliance. In Economics, what is alluded to are the twin information asymmetries problem of moral hazard and adverse selection. Considering both market agents, the benefits from these standards are the positive externalities provided, a reduction in the necessary transaction costs and potential search costs for better products.

As a form of incentive, these types of standards funnel innovative activities toward developing least cost of compliance with minimum quality and further improving existing safety precautions. There are standards which homogenize output variety. Origins for these standards could be privately initiated to those which are publicly mandated. Motivations for introduction are similarly varied ranging from the drive toward efficiencies from product standardization to preserving a business’ reputation. Examples which can be cited are the standardization of footwear sizes, car components and classification of product categories (SUVs vs mini-vans). These standards are sometimes blamed for lower consumers utility derived from having something different. Nevertheless, these standards encourage exploitation of efficiencies from mass production and exploitation of economies of scale. Also, standardizing output can be considered positive in creating greater cohesion among producers in an output’s entire value chain. Incentives to innovate with these standards will be influence by the quest to generate efficiencies from economies of scale, better and faster production methods within the entire value chain.

There are standards which can be considered a hybrid of the previous three types: providing information about the physical attributes of products. Although providing physical attributes of products may be related to safety, the main intent for these standards revolves around the proper use and deriving maximum benefits from products. Some examples that can be cited will be the maximum weight of air travel luggage, power voltage and electrical cycles and circumferences of metal bolts. Being a combination of the previous type of standards, the economic effects are expectedly an amalgamation of the previous three standards. These standards reduce both transaction costs and the risks on the user side. Manufacturers and vendors tend to standardize around the physical attributes provided. As an incentive to innovate, diverse routes will be taken. Some innovations will strive to extract efficiencies from standardization while others will go for lowering transaction costs.

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Joel Q. Tanchuco is an assistant professor at the School of Economics of De La Salle University, Manila. His research interests include energy economics, natural resource economics and development economics. He has a BS in Applied Economics from DLSU and an MA in Economics from the University of the Philippines, Diliman. He can be contacted via e-mail at [email protected].