By: Alex Vronces, Executive Director, PayTechs of Canada
Remember when Paul Krugman wrote about the effect the Internet would have on the economy? “By 2005, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s,” he said in Time magazine in the late 1990s. Since then, however, the Internet has toppled governments and disrupted the economy as we once knew it.
Duncan Watts said history can’t be told while it’s happening — neither by Nobel-prize winning economists, apparently, nor by anyone else. Yet some of us in the conversation about payment system modernization and open banking are being asked to do something harder: tell history before it even happens.
How exactly will Canadians benefit if fintechs are given access to the faster payment system when it goes live next year? How many fintechs will choose to access the new payment system when they’re permitted to? What precisely will Canadians be able to do, which they can’t do already, if the federal government pushes the financial industry to stand up an open banking ecosystem?
These questions are fine for the coffeehouse, but they shouldn’t be the focal points of policymakers’ conversation about payment system modernization and open banking. If we want more responsible innovation in the financial sector, we can’t condition legislative change on the supply of compelling answers to such myopic and hairsplitting questions.
Let’s not forget how innovation works
Imagine if the advent of personal computers depended on legislative change and such questions in the 1970s, when Ken Olsen, founder of Digital Equipment Corporation, is reported to have said, “There is no reason anyone would want a computer in their homes.” We’d probably have no personal computers. And we’d probably have never discovered how wrong Ken Olsen was.
Innovation isn’t sudden. It is, as Matt Ridley catalogued in How Innovation Works, slow and incremental, difficult to pinpoint to any one breakthrough. Game-changing eureka! moments are things of fiction. When something is invented, it needs to work. But it also needs to be deployed and adopted at scale, which can take decades as paradigms are broken and made anew.
Computers are one example of how slowly innovation diffuses through society. Electricity is another.
In the 1870s the lightbulb was invented. Electricity generating stations followed, making an appearance in London in 1881. Then came the electric motor a year later, beginning its slow displacement of how manufacturing plants were powered in the eighteenth century: the steam-powered engine.
Energy from a steam-powered engine wasn’t cheap. A large and complex energy-producing apparatus, it was costly to outfit a factory with a steam-powered engine. It also produced energy inefficiently. Even if you needed to power just one machine in a factory, you’d be shovelling enough coal into the fire to run them all.
Electric motors were supposed to be a game-changer. Outfitting a factory with them would cost less. You also wouldn’t need to run the whole energy-producing system to operate just one machine, and so you could better economize on energy usage.
“At the turn of the century, farsighted engineers already had envisaged profound transformations that electrification would bring to factories,” said economist Paul David in an essay in the American Economic Review.
But the promises of farsighted engineers weren’t being fulfilled. Though the electric motor was supposed to be a game-changer, the game had stayed the same for decades after the electric motor was invented. As Paul David wrote, “electric motors installed in manufacturing establishments in the country represented less than 5 percent of factory mechanical drive” by 1900.
Why the lag? Because you couldn’t deliver on the promise of the farsighted engineers “simply by ripping out the steam engine and replacing it with an electric motor,” as Tim Harford explained. “You needed to change everything: the architecture and the production process” of the factory itself.
In other words, you needed to reimagine what a factory even was. When that happened, nearly 40 years after the electric motor was invented, American manufacturing productivity soared.
Think bigger for better questions
If we’re going to get the most out of payment system modernization and open banking, we shouldn’t be asking others to describe what the supporting legislative change will immediately do for us in concrete terms.
The problem with myopic and hairsplitting questions is that they miss the point. The effects of legislative change over a few years says little about the effects of legislative change over decades, which is the time horizon over which innovation diffuses throughout society.
Instead, we should be asking what the federal government ought to do to make sure the future of financial services works for everyone, not just incumbent financial institutions. We should be asking what the federal government ought to do now to support the slow and incremental journey toward a better future of financial services.
We have some answers. A start would be to modernize financial sector regulation, making fintechs more independent of incumbent financial institutions. Moreover, open banking is already happening, just by unsafe means, and so federal legislation spelling out the dos and don’ts can’t hurt.
The more immediate benefits to such legislative change are a safer and more efficient financial sector, but that’s just the beginning.
We can’t yet imagine what the benefits will be in the long-run, just like Paul Krugman couldn’t imagine the long-run effects of the Internet on the economy. And if the history of electricity can teach us anything, it’s that we won’t see those benefits until we unshackle ourselves from the status quo and reimagine the fundamentals of financial services.