Sedimentary Innovation: How Regulation Should Respond to Incremental Change

As captivating as paradigm-changing "radical" innovations may be, “sedimentary”, or incremental, innovation – incremental improvements based on imitation, tweaking, bricolage and diffusion – are in fact the main way in which innovation actually develops. In finance, sedimentary innovation is shaped by forces including structural and social networks, a strong first mover advantage, and collective action problems. This piece, which is Chapter 8 in a forthcoming book that considers financial innovation as a regulatory challenge, examines sedimentary innovation in particular. Like innovation generally, sedimentary innovation can profoundly undermine regulation across time. It can bury structures designed to contain it and can transform the landscape, even while not seeming to be doing much at all. Sedimentary innovation is conceptually linked to flexible regulation (the book's other main concern), but also presents challenges for it. For example, humans struggle to recognize sedimentary change in real time, due among other things to cognitive limitations and bounded rationality. Regulatory boundary and coordination problems also pose unique problems in this context. The chapter offers some regulatory responses to the challenges posed by sedimentary innovation, including improving analytic capacity, recognizing network effects and predictable cognitive limits, and building in institutional contrarians and system “breakers”.