Academic journal article Chicago Fed Letter

The Economics of Standards: Public Policy and Market Performance

Academic journal article Chicago Fed Letter

The Economics of Standards: Public Policy and Market Performance

Article excerpt

As technology rapidly transforms many traditional sectors, the Fed and other public service providers are increasingly concerned about standards. The process for standards setting is complex with competing players and perspectives, and the fundamental economic principles are not clear cut.

On May 13-14, 2004, the Federal Reserve Bank of Chicago and Northwestern University cosponsored a conference titled "Standards and Public Policy." The conference brought together about 40 experts in public policy on standards, including economists from academia, the Federal Reserve System, and industry. This Chicago Fed Letter summarizes the conference presentations, which focused on the economics of standards competition, committees and standards organizations, compatibility and standards policy, and governmental approaches to standards policy. All papers presented at the conference can be accessed at: www.chicagofed.org/news_ and_ conferences/conferences_and_events/2004_ standards_emerging_payments_agenda.cfm.

In his introductory remarks, Michael Moskow, president and chief executive officer at the Chicago Fed, emphasized that as technology rapidly transforms many traditional sectors, the Fed and other public service providers are increasingly concerned about standards. Moskow noted that often the process for standards setting is an uncertain and complex activity with competing players and perspectives. Furthermore, the fundamental economic principles are not clear cut and have just recently been gaining significant attention. He pointed out that the payments market, in particular, has seen a transition from checks to new electronic payment instruments, highlighting the need for common interoperability standards. Therefore, the Fed is confronted with the particularly difficult task of finding the proper public policy position in the payments market, while balancing its dual roles as public service provider and market participant. Because the research presented at the conference balances realworld concerns with critical academic thinking, it may provide helpful insights to those interested in making informed public policy decisions on standards.

The economics of standards competition

In the first session, Timothy F. Bresnahan, Stanford University, presented a paper, coauthored with Pai-Ling Yin of Harvard Business School, that studied both economic and technical forces affecting the diffusion of web browsers. The authors focused their analysis on the late 1990s, when both personal computer (PC) sales and web use exploded.

Bresnahan noted that people were "rationally ignorant" when it came to selecting browser software: by and large, they used the browser that came with their computer. Hence, the primary force behind the adoption of new browser versions was the diffusion of new PCs, rather than any improvements in browsers themselves. He suggested that looking at the diffusion process, rather than just the determinants of a shift in technology, adds significant insight to our understanding of the overall economics of technical change.

Marc Rysman, Boston University, presented a joint paper with Shane Greeristein, Northwestern University, focusing on the early 56K-modem market, to highlight the coordination costs of resolving a standards war. The standards war in the 56K-modem market involved two very similar network technologies. The standard-setting organization (SSO), the International Telecommunications Union (ITU), was apparently helpful in resolving the conflict between the technologies by establishing a focal point for the industry. However, the development of focal points carries costs: in this case, membership, meeting, submission, and negotiation costs associated with the standard-setting process, as well as implicit costs that can make it difficult to reach an effective consensus. For example, when participants have imperfect information, confusion and misunderstandings may delay the process. …

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