Regulation, Innovation, & Entrepreneurship: A Review of the Literature

Literature
by Ana Maria Zárate Moreno, Research Assistant
December 08, 2015

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Abstract

The impact of regulation on innovation and entrepreneurship is a concern all over the world. The regulatory environment in which firms interact can hinder or contribute to the creation and early stage growth of new businesses as well as to the innovative process within a market. This document reviews the empirical literature that explores the relationship between regulation and innovation and regulation and entrepreneurship, focusing on the effects of regulatory quality across countries. As expected, most empirical analyses find a relationship between regulatory restrictions and entrepreneurship. Moreover, the analysis illustrates the complexity of the effect of regulation on innovation. The thematic analysis conducted in this literature review indicates that institutions matter for economic activities and that regulation, as an important part of the institutional environment, is a central aspect of the ecosystem for innovation and entrepreneurial engagement. 

The effects of regulation on innovation and entrepreneurship

In the United States and around the world, awareness of the effects of regulation on innovation and entrepreneurship is increasing. The regulatory environment determines “a certain coding for action, a coding that signals whether various acts are permitted (even required) or prohibited, whether they will be viewed positively, negatively or neutrally, whether they are incentivized or disincentivized, whether they are likely to be praised or criticized, whether they are possible or impossible.”[1] The particular characteristics of such regulatory context can hinder or contribute to the creation and early stage growth of new businesses as well as to the innovation process within a market. Considering this, a deeper understanding of these dynamics is key to improving the effect of regulation on innovation and entrepreneurial ecosystems.

Entrepreneurial activity is central for economic growth and job creation. But, “a combination of opportunity, capabilities and resources does not necessarily lead to entrepreneurship if opportunity costs (e.g. forgone salary and loss of health insurance) and start-up costs outweigh the potential benefits. The regulatory framework is a critical factor affecting countries’ entrepreneurial performance.”[2] Entrepreneurs are particularly affected by administrative regulation that creates entry barriers.

According to Richard B. Stewart, the “effective level of social performance demanded” and the particular form of regulation used determine the effect of regulation on firm-level innovation.[3] This points to the importance of: i) understanding the relationship between regulation and technology, ii) encouraging competition, iii) rationalizing regulations, iv) using performance, economic incentives, and other technology driving approaches, and v) harmonizing among jurisdictions, to “improve the positive regulatory effects on innovation without jeopardizing the original regulatory objectives.”[4]

Regulatory policies all over the world are increasingly including these considerations in their regulatory process. For example, both the European Union[5] and the United States[6] take into account the potential impacts on innovation in their regulatory assessments. Furthermore, the 2012 Recommendation of the Council on Regulatory Policy and Governance of the OECD encouraged governments to “commit to apply regulatory policy principles when preparing regulations that implement sectoral policies, and strive to ensure that regulations serve the public interest in promoting and benefitting from trade, competition and innovation while reducing system risk to the extent practicable.”[7]

Although there have been efforts to study the relationship between regulation and economic outcomes[8],[9],[10] there does not appear to be a systematic review of research examining the empirical relationship between regulation, with a non-sectoral focus, and innovation and/or entrepreneurship. This study attempts to fill this gap by conducting a comprehensive review of the econometric studies that explore the relationship between “better” regulation and innovation and entrepreneurship.

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[1] Brownsword , R., & Goodwin, M. (2012). Law and the Technologies of the Twenty-First Century. Cambridge: Cambridge University Press: 27.

[2]  OECD. (2012). Entrepreneurship at a Glance 2012. Paris: OECD. Retrieved July 23, 2015, from http://www.oecd-ilibrary.org/docserver/download/3012011e.pdf?expires=1437663045&id=id&accname=guest&checksum=3D01B24F1437D934878BE0D2E9853C9B: 106.

[3]  Stewart, R. B. (1981, Sep). “Regulation, Innovation, and Administrative Law: A Conceptual Framework.” California Law Review, Vol. 69, No. 5, 1256-1377.

[4]  OECD. (1996). Regulatory Reform and Innovation. Paris: OECD.

[5] European Commission. (2015). Better Regulation Guidelines. Strasbourg. Retrieved July 21, 2015, from http://ec.europa.eu/smart-regulation/guidelines/docs/swd_br_guidelines_en.pdf.

[6] Office of Management and Budget. (2003). Circular A-4. Retrieved July 21, 2015, from https://www.whitehouse.gov/omb/circulars_a004_a-4/.

[7]  OECD. (2012a). Recommendation of the Council on Regulatory Policy and Governance. Paris: OECD. Retrieved from http://www.oecd.org/gov/regulatory-policy/49990817.pdf: 7.

[8] Parker, D., & Kirkpatrick, C. (2012). Measuring Regulatory Performance, The Economic Impact of Regulatory Policy: A Literature Review of Quantitative Evidence. OECD,. Paris: OECD.

[9] Frontier Economics. (2012). The impact of regulation on growth: A Report. Prepared for the Department of Business, Innovation and Skills. London: Frontier Economics Ltd, London.

[10] Schiantarelli, F. (2005). “Product Market Regulation and Macroeconomic Performance: A Review of Cross-Country Evidence”. Vol 1791. Word Bank Publications.