Can too much regulation harm innovation?
Technologists may be right to view regulation with caution: a new draft for the National Bureau of Economic Research shows that regulation can inhibit innovation. Specifically, companies are hesitant to invest in their operations as hiring more employees increases regulatory scrutiny.
The document details the findings of John Van Reenendigital researcher at MIT Digital Economy Initiativeand co-authors Philippe Aghion And Antonin Bergeaudwhich created a model to assess the impact of market regulation, even in countries whose regulations differ from those in the United States.
In most countries, including the United States, regulations vary depending on the size of the business. If a company’s employee count remains below a certain number, it is generally not subject to stricter regulation, Van Reenen said. In the United States, for example, if a company has at least 50 full-time employees, it is considered a applicable large employer and is subject to the employer’s shared responsibility provisions and the employer’s information reporting provisions.
In a recent conversation Along with Andrew McAfee, co-director of the IDE, Van Reenen explained that he and his colleagues chose France to test their model, given that the country has some of the strictest labor regulations in the world. According to data from the Organization for Economic Co-operation and Development, France and Belgium rank highest in terms of regulation.
“In France in particular, when companies reach a certain size – 50 employees – a variable tsunami of labor market regulation falls on them,” Van Reenen said in a presentation. More specifically, companies must:
- Create a works council with employee representation.
- Provide union representation.
- Create a profit sharing system.
- Spend a minimum percentage of your income on training.
The authors wonder about the impact of the increase in workforce: were companies reluctant to expand when they knew that having more than 50 employees would lead to more regulation?
They analyzed a dataset spanning 1994 to 2007 containing corporate tax records, with the aim of identifying French companies and their associated employment information. They then compared the results with a global dataset of patent applications for the same period, which they used as an indicator of innovation. Finally, they compared French companies’ patents using a machine learning algorithm and measured market size using French customs data to characterize export markets, studying 182,348 distinct companies .
Regulation harms innovation
Van Reenen and his co-researchers found that two groups of companies were particularly affected.
- Companies close to the 50 employee mark have innovated less. “As you get to the 50 mark, there’s a real slowdown” in patent innovation, and it levels off just beyond 50, Van Reenen said. “There is an innovation valley just before that threshold of 50, which is consistent with the idea that companies innovate less because they are afraid to cross the threshold. Companies with fewer than 50 employees react less to promising market opportunities because they know they will have to pay an additional cost.”
- Large companies are also affected. The incentive to innovate diminishes as companies grow, because they know that every time they innovate they risk being taxed on their profits. (The authors were able to equate regulation with taxation using their model. They concluded that the impact of regulation is equivalent to a profit tax of around 2.5% which reduces overall innovation of ‘approximately 5.4%).
Additionally, researchers found that market size affects innovation: companies innovate more as market size increases. The larger the market, the more incentive companies have to innovate to profit from that market.
“As market size increases, companies innovate more,” Van Reenen said. “They can spread R&D costs across more units, which allows you to see more innovation.” The authors did not delve deeper into sectors, but noted that exporting manufacturing sectors were more patent-intensive than others.
How Businesses Are Trying to Mitigate Regulation
Van Reenen said that if a company wanted to grow without facing increased regulatory scrutiny, it could adopt more digital technologies instead of employing more workers.
A company could also ask its employees to work more hours instead of hiring more people to do the work, or rely on more skilled workers rather than unskilled workers, assuming that they are also smarter workers.
In fact, Van Reenen said research has shown that some companies make some of these changes as they approach the 50-person threshold.
“There’s a whole range of things that people do to try to get around the regulations that are in place,” he said. “The problem is that these things are not perfect substitutes. Digital technology is not a perfect replacement for work. We can’t make workers work an infinite number of hours.”