It's no secret that regulations can make or break a new business. Government rules on economic activities can be expensive or time-consuming to established firms. For new startups, they can be a non-starter. An entrepreneur can have an innovative idea to provide new goods and services at a higher quality or lower cost than the big boys that dominate the market. But if pioneering new firms can't handle high regulatory costs, those ideas might never come to be.
Regulatory reform can be hard, not least because incumbents often like the status quo. But small new entrants may have a lot to offer. Ideally, their services could be more affordable or higher quality than those provided by the current market. This means that regulatory barriers can serve to prevent access and lower costs for the people who might need it the most.
Thankfully, forward-looking policymakers have embraced a new kind of government innovation to help new business ideas get to market faster.
"Regulatory sandboxes" create a stripped-down regulatory environment where startups and entrepreneurs can experiment with new business concepts under the watch and light guidelines of regulators. It's a way to carve a space for innovation without wholesale regulatory reform, which can often be daunting.
Regulatory sandboxes are a fairly new phenomenon, with the first major effort dating back to the United Kingdom's Financial Conduct Authority (FCA), a "financial technology" (fintech) sandbox, some half a decade ago. Most regulatory sandboxes are for fintech, but there are other experiments for things like insurance, energy, and legal services. The World Bank tallies up 73 regulatory sandboxes across the world, with the majority of them being launched in the past two years.
Because regulatory sandboxes are so new, we have limited data on how effective they are to actually kickstart growth and innovation. The FCA is the oldest, so it has some lessons to offer. The results so far have been promising: Sandbox participants got to market 40 percent faster than non-participants; 80 percent of the participants graduated into the normal market; and participants attracted around £135 million ($187 million U.S.) in funding (around half of the participants ended up partnering with an incumbent firm).
This is not to say that regulatory sandboxes are some kind of panacea. As research by Brian Knight and Trace Mitchell points out, the design of a regulatory sandbox will matter a lot for the quality of final outcomes. For example, sandbox administrators could choose friends or allies to participate while leaving outsiders in the cold, which is just another way of picking winners or losers. Or administrators could give startups that choose not to apply (for whatever reason) extra—even vindictive—scrutiny. Regulatory sandboxes should not simply reproduce the same problems they were created to overcome.
Industry-by-industry sandboxes, like those created specifically for fintech, are a step in the right direction. But they are limited for some of the reasons that Knight and Mitchell point out. By excluding all non-"fintech" (or whatever the industry sandbox is) firms from a path to regulatory relief, industry-specific sandboxes necessarily prioritize some firms over others. Maybe there is a really innovative company that just doesn't fit the definition of "fintech" within some municipality that offers a fintech sandbox. They will be robbed of the ability to try out their ideas, and society will miss out on the potential benefits they could have provided.
Enter Utah's new general purpose regulatory sandbox, which was just passed by the state legislature and awaits the Governor's signature. It's a really innovative proposal, and it gets around some of the limitations of previous sandbox experiments.
Rather than granting punctuated regulatory relief on an industry-by-industry basis, Utah's general sandbox creates a new body, called the Office of Regulatory Relief (ORR), that any innovative new company can work with to seek sandbox participation. The company must submit an application to the ORR which explains their business model, which regulations are getting in the way, and how the state would benefit if they are able to participate in a sandbox program. The ORR reviews the application in consultation with the relevant regulatory agency. Successful applicants will receive regulatory exemptions for a one-year period and can apply for an annual extension after that.
Utah's mechanism design is set up with an eye towards preventing the problem of the government picking winners or losers. For example, applicants are asked whether any of their direct competitors have been granted a sandbox. If so, that would be a strong signal in favor of also granting that applicant a sandbox. It's not automatic, but it is geared towards making the ORR think seriously about the neutrality of their decisions.
It's obvious why businesses and consumers would benefit from regulatory sandboxes. Companies would get an opportunity to launch products to market that balances a lightened regulatory load with expert government oversight. Consumers get the benefits of trying out new products and services that might have otherwise never seen the light of day. In the best-case scenario, these greenlit business offerings can reach underserved populations at reasonable prices.
But regulatory sandboxes create great benefits for regulators themselves, too. When it comes to technology, things move fast. Even the most forward-looking oversight bodies struggle to keep up with changes in emerging technologies and adapt their rules to account for them.
Regulatory sandboxes can be just as much of an educational experience for regulators as they are for new businesses. It gives government overseers a crash course in new technologies and a direct line to the innovators that are building them. By working directly on the front lines of new innovation, regulators will be in a better position to tailor their rules so that they accomplish what they intend.
Of course, regulatory sandboxes should not be a substitute for robust regulatory reform. If Utah's ORR becomes inundated with applications for regulatory relief, it could be a signal that more general regulatory reforms are needed. In any event, it gives a good amount of breathing room that wouldn't have been there while lawmakers determine which reforms are appropriate.
The kind of regulatory relief that Utah's general purpose sandbox program promises could not have come at a better time. As vaccination rates creep up and COVID caseloads keep falling, we are finally getting to a place where our economy may be allowed to start recovering. Giving entrepreneurs a path to market viability is a great way to kickstart the kind of economic growth that we need. Let's hope that more states follow in Utah's footsteps and create general purpose sandboxes for their own economies.