Regulation and Innovation: Approaching Market Failure from Both Sides

Abstract

Across markets and disciplines, regulation is often claimed to be the enemy of socially desirable innovation because of factors including innovation’s unpredictability and regulation’s compliance costs. In this essay, we bring an intellectual property scholars’ perspective to bear on the question of regulation’s impact on innovation. We offer a novel, yet intuitive analytical framework that takes both market demand failures and failures of supplier appropriability into account. Traditionally, regulation seeks to mitigate market failures that create deviations between the demand portfolio perceived by suppliers and the socially optimal demand portfolio. Studies of the interplay between regulation and innovation have mostly taken this perspective, considering the impact of various regulatory transaction and compliance costs on innovation. Intellectual property law and competition law target a different sort of problem, where markets fail to supply products and services at competitive prices or to undertake innovative activities because of supplier appropriability issues.

We argue that these demand misalignment and appropriability failures, though analytically distinct and commonly treated separately, work in parallel and in combination to determine the extent to which the market’s portfolio of innovative activity is socially sub-optimal. Discussing the relationship between regulation and innovation in terms of demand misalignment, appropriability failures, and the mutual influence they bear on each other, opens up a new way of understanding this years-long debate. The analysis shows the futility of sweeping general pronouncements about the relationship between regulation and innovation and highlights the crucial role of regulatory design.

Keywords: regulation, innovation

JEL Classification: K2