The market for mobile apps on smartphones and other mobile devices has grown tremendously over the last few years. Indeed, it would be hard to find another sector that enjoys a similar level of creativity and innovation. Much of this vibrancy is driven by low barriers to entry and the fact that practically anyone with any level of programming savvy can try his or her hand at developing the next Angry Birds, with the hope of making millions.

Because of the highly decentralized and heterodox nature of this market, it is difficult to estimate its size. Various analyses have put it somewhere between $20.4 billion and $53 billion a year, with expectations that it will grow to between $63.5 billion and $143 billion by 2017.

That vibrancy has put apps under the scrutiny of state and federal regulators who worry about the effects of new technologies on the broader market. In many cases, the apps serve as a way of connecting users with services that have been around for a long time, but circumvent existing regulation of those services. Government agencies often see the apps as opening regulatory loopholes, and the agencies—often at the behest of incumbent firms that have long been bound by those regimes—are increasingly interested in finding ways to close them. Consider:

  • In Virginia, the Department of Motor Vehicles recently issued a cease-and-desist letter to popular app-based ride sharing services Uber and Lyft, threatening to pull over and arrest drivers suspected of using the services. The Virginia action follows developments in other states and cities, as regulators argue that the services unjustly compete with the taxicab industry because they avoid highly restricted and expensive cab licenses. (See “Nashville’s Competitive ‘Black Car’ Regulations,” Summer 2013.)
  • In New York, similar charges have been brought against Airbnb, an app that lets travelers find temporary lodging by paying to stay in people’s empty apartments. The city claims that Airbnb violates hotel licensing laws and aims to shut down the service.
  • A wide variety of food-based apps allow users to host dinner parties for strangers, offering the hungry and lonely a way to enjoy home-cooked meals and make new friends. The U.S. Food and Drug Administration, anxious about food being served for profit outside of rigorous local or state inspection procedures, is looking into ways to crack down on the service.
  • The FDA is interested in other sorts of apps as well, with the burgeoning field of health care apps attracting the bulk of its attention. These programs range from diagnostic tools, to heart rate monitors, to dietary advice, to general sources of information like WebMD and even Wikipedia. Since the FDA currently has the authority to regulate medical devices, they are seeking to expand their powers to the app-based software available for smartphones, citing concerns over health and safety as its motive. (See “The FDA Allows Apps for That,” Winter 2013–2014.)
  • Finally, the U.S. Department of Transportation is seeking to apply current bans on cell phone use while driving to voice-activated navigation apps. There is undoubtedly a qualitative difference between a personal conversation and a hands-free device designed to aid driving and eliminate the need for bulky paper maps, but it is the DOT’s position that a phone is a phone, regardless of how it is used.

Rent-seeking / What is notable in all those cases is the way in which innovation has allowed entrepreneurs to find ways around existing regulations—at least temporarily—and that many of the industries in question have been cartelized thanks to the government erecting substantial barriers to entry. Those industries are now pushing back against the apps.

Taxi companies want to prevent ride-sharing services because the current “taxi medallion” regulatory regime means that only a very few are able to compete, keeping prices high for incumbent firms. Hotels dislike Airbnb for the same reason. Restaurants feel cheated by apps allowing private dinner party organization, doctors and medical device makers want to keep patients coming to them instead of self-diagnosing, and the manufacturers of navigation systems fear obsolescence at the hands of mobile competitors.

The aim of regulators in most of these cases, with the notable exception of Uber and Airbnb, is not to eliminate the app-driven service entirely, but to subject it to the same kind of regulatory oversight as the cartelized incumbents. But what about the lost benefits to consumers, forgone economic activity, lost revenue, and the diminished incentives for innovation that result from regulating or prohibiting the app-driven services?

We can attempt to quantify a portion of those lost benefits by examining just the effect of delays necessary for regulatory review. Let us assume an average of one year for a new app to apply for and receive approval from the necessary government agency—probably a generous assumption given the current lack of personnel dedicated to such a purpose. The largest purveyor of mobile apps, Apple, enjoys an average of 40,000 downloads per app at an average revenue of 10 cents for each purchase. The Apple App Store adds about 20,000 new apps each month, totaling 240,000 a year. Thus, a one-year delay for all apps pending regulatory review would cost the economy an average of nearly $1 billion annually. Data for other app providers are unavailable, but it is safe to assume this would be just a fraction of the total cost of regulating apps. Furthermore, these numbers do not account for the disincentive effect a lengthy review process would have on the development of new apps, nor the unquantifiable benefits from the apps themselves, such as better health or safer driving, nor the cost to taxpayers of expanding the regulatory apparatus to monitor this new industry.

Uneven burden / As irksome as they seem, the complaints of lobbyists for existing businesses are not wholly without merit. It is true that there is currently an unequal burden of regulation, with those operating via mobile app interface escaping the rules that govern the rest of the industry. So what should be done to rectify this?

There are three potential options for regulators. First, the existing regulatory structure can be made to apply equally to all firms in an industry, whether they operate via mobile app or not. Existing cartels typically advocate this method because it allows them to preserve their position as privileged incumbents while forcing start-up competition out of the market. It may sound like the “fairest” solution, but the costs, as we have seen, are enormous.

Second, the current regulatory regime could be eliminated, applying the current model for mobile apps to other firms as well. Consumers would enjoy the gains of increased competition, lower prices, and more choice. And the cartelized incumbents would lose whatever benefits were provided by existing regulations. However, the practical (read: political) challenges of repealing such a broad array of regulations may be insurmountable, at least in the short term.

The third option is to leave things as they currently stand, with new technologies escaping the regulatory burden and slowly chipping away at the old regime. While this may seem like the least fair of the three options because it treats some firms differently than others, for the advocate of limited government it has some advantages.

Allowing new business models to escape regulation not only offers the benefit of more innovation and consumer choice, but it gradually incentivizes more and more firms to change the way they do business. As more companies alter their services in order to avoid existing regulations, the regulatory hold on the economy as a whole gradually and inexorably shrinks without the political difficulties of repealing dozens of individual laws. Over time, more and more firms will come to operate under the new models and the regulatory regime will have been all but demolished, all without the government having to lift a finger—a practical means to an idealistic end.

What needs to be determined is whether we are willing to tolerate a certain inequality in regulations in order to ultimately reduce the burden on everyone, or if equity considerations alone justify imposing the costs of current regulations on everyone.