The Impact of Regulation on Innovation
AbstractWe study the impact of labor regulation on innovation. We exploit the threshold
in labor market regulations in France which means that when a firm reaches 50
employees, costs increase substantially. We show theoretically and empirically that
the prospect of these regulatory costs discourages firms just below the threshold
from innovating (as measured by patent counts). This relationship emerges when
looking nonparametrically at patent density around the regulatory threshold and
also in a parametric exercise where we examine the heterogeneous response of firms
to exogenous market size shocks (from export market growth). On average, firms
innovate more when they experience a positive market size shock, but this relationship
significantly weakens when a firm is just below the regulatory threshold. Using
information on citations we show suggestive evidence (consistent with our model)
that regulation deters radical innovation much less than incremental innovation.
This suggests that with size-dependent regulation, companies innovate less, but if
they do try to innovate, they “swing for the fence”.