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Presentation: Regulation, Innovation and Technology Diffusion

Claudia Temgoua Monika Kęszczyk Sheng Zhong Shuyan Di MADE 1st Year Faculty of Economic Sciences University of Warsaw

Contents

1

Introduction

2

Regulation will lead to innovation

3

Regulation may be detrimental

4

Conclusions & Policy Implications

1. Introduction

Our Two Hypotheses

:

(1) Regulation will lead to innovation and technology diffusion.

VS (2) Regulation may be detrimental to innovation.

2. Regulation will lead to innovation

Brief Review: Economic growth is a consequence of innovation.

Firstly, according to the AK model: Y = AK Secondly, taking into account R&D: 2 cases

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Increasing the variety of products

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Improving the quality of products

2. Regulation will lead to innovation

Increasing the variety of products

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Production will be:

•

The growth is unconstrained Improving the quality of products

•

The more innovation a country has had, the more difficult to get a new one.

•

Devoting more resources to innovation

2. Regulation will lead to innovation

Empirical evidence: Acemoglu & Dell (2009)

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Data: labor incomes and household expenditure for 11 countries in the Americas (Canada, Latin America and the U.S.)

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Methodology: dominant empirical approach: Solow model

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Findings:

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Except human capital, the residual factors are significant

•

Given the Solow model, the determinants are technology differences

2. Regulation will lead to innovation

?

?

Innovation & Technology Progress

Positive Growth 3 ways of getting innovation: R&D spending, saving labor and purposeful activity (for example, trade and FDI); But, Regulation will affect these 3 ways; The impact is positive.

2. Regulation will lead to innovation

Once upon a time… In a 1991 essay in Scientific American, Michael Porter suggested:

•

environmental regulation may have a positive effect on the performance of domestic firms relative to their foreign competitors by stimulating domestic innovation.

2. Regulation will lead to innovation Two main reasons:

①

Patent issue

• More and more expensive to get innovation: firms will weigh the pros and cons of innovation • Without regulatory protection of patent, firms prefer to invest less in R&D, in order to gain as many benefits as possible • Patent protection → benefits from innovation

2. Regulation will lead to innovation

Example: Huawei Technologies Co. Ltd.

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multinational networking and telecommunications equipment supplier

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No. 2 in the global mobile infrastructure equipment market after Cisco

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2010 Contract orders: $30 billion

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2010 Revenue $28 billion

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2010 Net income $3.6 billion

2. Regulation will lead to innovation

Example: Huawei Technologies Co. Ltd.

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The fifth most innovative company in the world (2010), according to Fast Company

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According to the World Intellectual Property Organization (WIPO) in 2009, Huawei was ranked as the largest applicant under WIPO's Patent Cooperation Treaty (PCT), with 1737 applications.

2. Regulation will lead to innovation Two main reasons:

②

Shadow economy: less regulations, larger size of shadow economy

• • • •

Allocative efficiency: Small firms: lower production level Less investment on human capital Obstacles to foreign capital investment and technology transfer

•

Empirical evidence:

Eilat and Zinnes (2002)

2. Regulation will lead to innovation Two main reasons:

②

Shadow economy

•

Empirical evidence:

Eilat and Zinnes (2002) •

Data:

25 transition countries over the period 1990 to 1997 •

Methodology:

using MTE approach to measure shadow economy and checking the correlations between shadow activity and economic variables

2. Regulation will lead to innovation Two main reasons:

②

Shadow economy

•

Empirical evidence:

Eilat and Zinnes (2002) •

Findings:

shadow economy has a significantly negative and strong correction with competitiveness indicator, FDI, trade indicator, human development and labor quality.

2. Regulation will lead to innovation

More empirical studies:

•

ISI Web of Knowledge database (SSCI): 1191 papers

•

Sort all the papers by the numbers of being cited (from the most to the least)

2. Regulation will lead to innovation

More empirical studies:

•

Jaffe & Palmer(1997)

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Modeling: Where PACE is pollution control costs PACE is the name of a social survey

2. Regulation will lead to innovation

More empirical studies:

•

Jaffe & Palmer(1997)

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Data: Panel data, industry level, over 1975 to 1991

•

Findings: environmental regulation compliance expenditures have a significant positive effect on R&D expenditures

2. Regulation will lead to innovation

More empirical studies:

•

King & Lenox (2000)

•

Findings:

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Industry self-regulation has been proposed as a complement to government regulation;

•

But effective industry self-regulation is difficult to maintain without explicit sanctions

2. Regulation will lead to innovation

Bottom line:

•

Two main reasons & empirical studies: regulation will affect 3 ways of getting innovation.

•

Environmental regulation will stimulate certain types of innovation.

•

Effective industry self-regulation is difficult to maintain without explicit sanctions

3. Regulation may be detrimental

P1. REGULATION IS BAD FOR FIRMS IN EVERY SECTORS P1.1

Privatization, Liberalization and Free Competition

P1.2

Regulation, Total Factor Productivity (TFP), and Misallocation

P2. MORE SPECIFIC EVIDENCES P2.1

Information and Communication Technology (ICT)

P2.2

Pharmaceutical Industry

P2.3

Environmental Regulation (ER)

3. Regulation may be detrimental

P1. IN EVERY SECTORS

 Giuseppe Nicoletti and Stefano Scarpetta (2003): A negative relationship between market barriers or State control and catch-up in technology in the manufacturing sector.  A more liberalized, privatized country and further away from technology leader country, the more benefit from innovation and so in productivity.

3. Regulation may be detrimental

P1. IN EVERY SECTORS

 Regulation has an indirect influence on growth through creation of technology gap.

 NO privatization, NO liberalization and NO free competition.  Negatively affects: the use and allocation of inputs (resources), the spread out of new technology, and the promotion of innovative activities.

3. Regulation may be detrimental

P1. IN EVERY SECTORS P1.1 Privatization

 Property Rights firm owners’ motivations and objectives.

 Favor networking and collaboration managerial innovation and spread over of new technology.  Profits increase and cost reduction.

3. Regulation may be detrimental

P1. IN EVERY SECTORS P1.1 Liberalization

 The lower entry barriers and state control, the faster the process of catch-up to best-practice technologies in manufacturing industries.  Giuseppe Nicoletti and Stefano Scarpetta (2003), OECD countries  Due to liberalization: Annual Multifactor Productivity growth rate in service industries = about 0.1-0.2 percentage points. In Greece, Portugal and Italy.

 Due to removal of trade and administrative barriers: Annual Productivity growth rate 0.1-0.2 percentage points. In Germany, France, Italy, Greece.

3. Regulation may be detrimental

P1. IN EVERY SECTORS P1.1 Free Competition

 Positive relation between competition and innovative activities.

 Nickell (1996), Blundell et al. (1995, 1999) and Bassanini and Ernst (2002).  However, product market competition is hampered by state control and barrier to entry.

3. Regulation may be detrimental

P1.2 REGULATION, TFP, MISALLOCATION

 In the real business cycle literature, regulations have negative impacts on productivity and TFP.

 In the literature on growth and development, misallocation potentially reduces TFP and overall output. Moreover, misallocation can lead to income differences.

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation Simple Theoretical Explanation

 How may regulations be detrimental to innovation and technology diffusion?

 A toy model by Charles I. Jones (2011). “MISALLOCATION, ECONOMIC GROWTH, AND INPUT-OUTPUT ECONOMICS”  Cobb-Douglas function: Where, A = TFP

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation



A Toy Model A perfect competitive market

(1.2.1) (1.2.2) (1.2.3) 

Decision of the labor input allocation

(1.2.4)

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model

 Solving for GDP given the allocation yields: (1.2.5)  where TFP is given by  Optimal allocation of labor: (1.2.6) (1.2.7)

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model

 If production function (1.2.3) is given in a general form:

0 < σ < 1

(1.2.8)  then TFP would be: (1.2.9)  To simplify, we will take

σ= 1/2 Company Logo

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model

 Figure 1 TFP and the allocation decision in a perfect market. [Source: Charles I. Jones (2011)]

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model

 In the reality, as in Chari, Kehoe and McGrattan (2007), Hsieh and Klenow (2009), Lagos (2006), and Restuccia and Rogerson (2003)  Distortions, for instance, taxes and regulations at the sectoral level can aggregate up to provide differences in TFP. The decision of the planner could be twisted by the regulations into an alternative shape (see Figure 2)

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model Regulations among plants

 Figure 2 Regulation, TFP and the allocation decision in reality.

[Source: Charles I. Jones (2011)]

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation A Toy Model Regulations within plants

 Figure 3 Regulation, TFP and misallocation.

[Source self made]

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation

 The same change of the input factor △ x results in a larger decrease of TFP in the present of regulations than the one without.  Does the shift of input factor △ x due to the differences in preferences?  NO!!!  The difference in preferences is an endogenous outcome.

 The misallocation is caused by the regulations within plants.

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation

 Misallocation due to the regulations within plants maybe:  the plant manager is not the best person for the job (Caselli and Gennaioli, 2005);  the most talented workers within the plant are not promoted to the appropriate positions (Lazear, 2000);  unionization and job protection leads the firm to use too much labor inappropriately (Schmitz, 2005), and so on.

 Regulations may lead to misallocation.  Misallocation reduces TFP.

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3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation Evidences



Regulations have negative impact on productivity and TFP.

 Chu (2001) and Restuccia and Rogerson (2003): government policies (regulations) at the levels of plants and establishments lower aggregate productivity.

 Lagos (2006): labor market policies (regulations) lead to misallocations of labor across firms, thus, to lower aggregate productivity.

 Chari, Kehoe and McGrattan (2007): regulations show up as TFP shocks.

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation Evidences



Misallocation caused by regulations potentially reduces TFP and overall output, also leads to income differences.

 Hsieh and Klenow (2009): misallocation across plants within 4-digit industries may reduce TFP in manufacturing by a factor of two to three in China and India.

 Parente and Prescott (1999), Caselli and Gennaioli (2005), Lagos (2006), Alfaro, Charlton and Kanczuk (2008), Buera and Shin (2008), Guner, Ventura and Xu (2008), La Porta and Shleifer (2008), Bartelsman, Haltiwanger and Scarpetta (2009), Vollrath (2009), Midrigan and Xu (2010), Moll (2010), and Syverson (2010).

3. Regulation may be detrimental

P1.2 Regulation, TFP, and Misallocation

    

Evidences

Charles I. Jones (2011) - intermediate goods. Input-Output Economic Model with imported and domestic intermediate goods in N sectors Data of 480 U.S. Industries in 1997; in 2000 input output data for 35 countries and 48 industries. The effect of misallocation can be amplified through the input-output structure of the economy. A given amount of misallocation can lead to large income differences in different countries at different levels of development.

3. Regulation may be detrimental

P2. More Specific Evidences ICT Industry

 Prieger (2002), USA,  Innovation difference between regulated and unregulated scenarios = 4.3 services per year. The expected delay effect accounts for much of the reduction in innovation under the CEI regime.

3. Regulation may be detrimental

P2. More Specific Evidences Pharmaceutical Industry

 Vernon (2003), US, regulation of prices reduces R&D and thus innovation.  Annual innovative productivity falls down by between 67 and 73% relative to baseline (with price regulations)  Cumulative innovative output fell by between 30 and 37%.  Price controls reduce R&D investment, and therefore innovation.

3. Regulation may be detrimental

P2. More Specific Evidences Environmental Regulations

 Gollop and Roberts (1983), 56 U.S. electric utilities, 1973– 1979. ---- ERs reduce productivity growth by 43%.

 Smith and Sims (1985), 4 Canadian beer breweries, 1971–1980. ---- Average productivity growth:  regulated–0.08%, unregulated +1.6% .

Gray (1987), 450 U.S. manufacturing industries, 1958–1978 ----  30% of the decline in productivity growth in the 1970s due to ERs

3. Regulation may be detrimental

P2. More Specific Evidences Environmental Regulations

 Berman and Bui (2001), U.S. petroleum refining industry, 1987–1995.

 Stricter regulations imply higher abatement costs.

Gray and Shadbegian (2003), 116 U.S. paper mills, 1979–1990.

Significant reduction in productivity associated with abatement efforts particularly in integrated paper mills.

3. Regulation may be detrimental

P2. More Specific Evidences Environmental Regulations

 Rassier and Earnhart (2010), 73 U.S. chemical firms, 1995–2001.

 Tighter regulations meaningfully lower profitability.

Lanoie et al. (2010), 4,200 manufacturing facilities in 7 OECD countries in 2003 Tighter ER increases R&D, which improves business performance; however, direct effect of ER is negative, and combined impact is negative -

innovation offsets do not offset cost of ER

4. Conclusions



the more a country is liberalized, the more it benefits from innovation



privatization is a strong basis for innovation and spread over of new technology



liberalization has a positive impact on innovation and technology



regulations have a negative impact on productivity and Total Factor Productivity (TFP)



misallocation caused by regulations potentially reduces TFP

4. Conclusions



regulation affects three ways of getting innovation: R&D spending, saving labor and purposeful activity



shadow economy has a negative and strong correction with competitiveness indicator, FDI, trade indicator, human development and labor quality



environmental regulation compliance expenditures have a significant positive effect on R&D expenditures



effective industry self-regulation is difficult to maintain without explicit sanctions

References

•Ambec, Stefan, Mark Cohen, Stewart Elgie, and Paul Lanoie (2011). “The Porter Hypothesis at 20: Can Environmental Regulation Enhance Innovation and Competitiveness?” Discussion paper, RFF DP 11-01.

•Charles I. Jones (2011): Misallocation, Economic Growth, and Input-output Economics.

•Eilat, Y. & Zinnes, C., 2002, “The shadow economy in transition countries: friend or foe? A policy perspective”,

World Development

, 30(7), pp. 1233-1254.

•Hsieh, Chang-Tai and Peter J. Klen, data study”,

Quarterly Journal of Economics

, “Misallocation and Manufacturing TFP in China and India,”, 2009, 124 (4), 1403–1448.

•Jaffe, A., B. & Palmer, K., 1997, “Environmental regulation and innovation: A panel

Review of Economics and Statistics

chemical industry's Responsible Care Program”, , 79(4), pp. 610-619.

•King, A., A. & Lenox, M., J., 2000, “Industry self-regulation without sanctions: The

Academy of Management Journal

, 43(4), pp. 698-716.

•Lagos, R. (2006): “A Model of TFP,”

Review of Economic Studies

, 73, 983 —1007.

References

•Lanoie, P., J. Lucchetti, N. Johnstone, and S. Ambec (forthcoming), Environmental Policy, Innovation and Performance: New Insights on the Porter Hypothesis,

Journal of Economics and Management Strategy

.

•Nicoletti, G. and Scarpetta, S. (2003) "Regulation, Productivity and Growth: OECD Evidence" ,

Economic policy

, 2003 - Wiley Online Library. •Prieger, (2002), “ Regulation, Innovation And The Introduction of New Telecommunications Services”,

Review of Economics and Statistics

, 2002 - MIT Press. •Restuccia, D., and R. Rogerson (2003): “Policy Distortions and Aggregate Productivity with Heterogeneous Plants,” Innovation”,

Manuscript

, Arizona State University.

•Vernon, J. A.(2003), “Simulating the Impact of Price Regulation on Pharmaceutical

Pharmaceutical Development and Regulation

, 2003 – ingentaconnect.com.

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