States as Firms: Regulation in the Digital Age

Resident Evil, the popular video game series, is as brilliant and horrifying as it is informative and thought-provoking. Taking place in imaginary cities across the United States (and recently, Europe), the series follow the Umbrella Corporation, a pharmaceutical giant practicing eugenics with terrible consequences for the world. Apart from grotesque depictions of medical experiments gone wrong, Resident Evil also conveys a more fundamental message: risks of enormous corporations capturing the state apparatus to further their own agenda instead of public welfare.

The great economist Armen Alchian once argued: “whoever has a value that is firm-specific will seek to gain some form of control over the firm.” A prominent example is labor unions. As firm workers make specific investments (e.g., by learning skills usable in that firm in response to employer promises), they will seek representation on the corporate board to ensure their investments do not get expropriated. Similarly, banks are known to monitor the decisions of firms to whom they supplied loans. The International Monetary Fund carries this dynamic to the international level by imposing country-specific obligations on indebted states to observe the propriety of sovereign economic activity. In such cases, the state becomes “the firm”.

States are frequently equated with corporate entities. For example, neoliberal accounts often view government as a supplier of policy, and the electorate as consumers. Similarly, economic studies of parliaments see legislation as a “good” – output manufactured by the legislature. There are anecdotal examples marking the similarities between states and corporations as well. The British Monarchy is colloquially called “The Firm”, whereas state apparatuses like the Central Intelligence Agency (CIA) of the United States are sometimes known simply as “The Company”. Beyond pure wordplay, these analogies have interesting implications for regulation.

Economic theory suggests that exercise of state power is vulnerable to interest capture. As Nobel Laureate George Stigler’s famous work has discussed, “regulation is acquired by the industry and is designed and operated primarily for its benefit”. More recently, Holcombe observes the vulnerability of regulation to corruption, since “regulation is explicitly designed either to force people to do things they would not otherwise choose to do” (or vice-versa). Such models acknowledge that a supply-and-demand relationship exists between the regulators and the regulated. There is more to regulatory policy than pursuing public interest; private interests could be mobilized to achieve private gains at the expense of society. Risks of capture led many scholars to react suspiciously to “predation through regulation”.  Elsewhere, court rulings recognized complaints lodged against competitors as attempts to instrumentalize the law as a balm to wounds inflicted by competition.

The fictional (but eerie) case of the Umbrella Corporation hints at a slightly different account. Part of Alchian’s work suggests that firm-specific investments induce the investor to gain control of the firm. In one of the games, the Umbrella Corporation seeks to participate in governing the local municipality and police force – both to gain access to competitive advantages (e.g., obtaining test subjects), and to dissuade competitors. This is a case of “asset-specificity” or “dependency” – Umbrella is initially dependent on the government because of the massive investments it made in Raccoon City. However, there are two sides to this relationship. Entities making firm-specific investments can flip the script by becoming “unique” resources. In such a scenario, the firm becomes dependent on the investor. Imagine a superstar employee threatening to leave work, an extremely popular app withdrawing from the App Store, or a show with a wide audience pulling out of Netflix. All three would command considerable bargaining power due to their unique stature vis-a-vis the firm.

A state-centric analogy is apt. Considering the government as a firm reveals an inherent weakness toward entities that achieved a unique status. Corporations with relative power over the state-firm may extract concessions by threatening to leave or relocate. This is known in the economic literature as the hold-up problem. Extreme examples of corporations threatening to leave can be observed quite recently. For instance, faced with the threat of regulation concerning online news content, Facebook and Google voiced intentions to cease operations in Australia. Recently, similar claims echoed in Canada as well.

In the Resident Evil universe, we witness the dependence/uniqueness scenario unravel in favor of the Umbrella Corporation. Having become the largest company in the United States, as well as a major employer, it is able to dictate policy even in the face of civilizational collapse. In real life, things reflect a more ambiguous power dynamic. Dependence in real life is often reciprocal. This typically introduces balance to inter- and intra-firm relationships, as both sides could hold the threat of expropriating the other’s specific investments, thus keeping each other in check.

Nevertheless, the theoretical possibility of holding a partner to account does not always translate into a practical ability. Consider a landowner renting space for a skyscraper. Although the skyscraper has land-specific investments, it is unfeasible for the landowner to modify the services provided by the land. In such cases, uniqueness or dependence does not lead to a commensurate degree of bargaining power. In a similar vein, it is unclear to what extent states can threaten to expropriate digital firms’ investments in their territory and population. While “banning” an application is theoretically possible, it may be practically impossible and politically unfeasible. One needs only to look at the United States’ efforts to ban TikTok; broader efforts have hitherto failed and only few states could claim success in prohibiting their officials from using the app. The broadening availability of tools to bypass governmental prohibitions on the internet further exacerbates the states’ position.

None of the above should be taken as an acknowledgement of sovereign weakness against mega-corporations of the digital age. To the contrary, contemporary literature suggests that the return of the state is in motion. Governments retain a variety of gadgets at their disposal to constrain firm behavior. Furthermore, as the globalization drive decelerates, the states reassert their right to regulate in the international realm, for example through reforming the international investment arbitration system. The challenge of regulation in the digital age lies in mitigating the extremes of public and private power.

It is true that the government holds the guns, but it is also important to remain wary of those manufacturing the guns. Second, one must be vigilant to avoid a state Orwellian in scale and power while running scared from the perils of a Brave New World, dominated by the likes of the Umbrella Corporation.