The Schumpeterian Cost of Regulation on Entry and Innovation: The Case of Bail Bonds

Abstract

Entrepreneurship is valued in part because it stimulates Schumpeter’s gale of creative destruction. A popular view, reinforced by recent empirical work on regulatory reform, is that regulation inhibits entrepreneurship and innovation. However dismantling regulation is ill-advised, since generally regulation has primary goals other than to increase innovation. We study the impact of regulation on entry and innovation in such a setting, the bail bond industry. We build structural models of the entrepreneur’s entry decision and the incumbent’s continuation decision, then employ recovered parameter estimates in counterfactual policy environments that allow us to compare the impact of different regulatory regimes. Results from this exercise indicate that a combination of entry and operating regulations reduces entry yet increases innovation relative to a setting with no regulation. These benefits are above and beyond the intended benefits of the regulations. Our results suggest it is possible to design regulations without imposing the Schumpeterian cost on innovation, and provide preliminary indications of how to accomplish this. Moreover our results suggest that Schumpeterian cost itself may need to be redefined. Entry and innovation actually oppose one another in our setting. Not only does excess entry steal share, in so doing it also suppresses incentives to innovate.

Keywords: entry, innovation, regulation

JEL Classification: L1, L5, O4