General Seminar - Hongyi Li

Regulating an innovative Industry

Abstract: Innovations bring many benefits to society, but they can also bring harm. We study the problem of a regulator deciding whether to approve an innovation where information about the impact of the innovation is held within the firms that are developing it. We show that competition for the innovation can undermine the regulator’s ability to extract the information she needs to make good policy. As a result, the relationship between competition and innovation is very different in regulated environments. In fact, we show that the political failure can be so severe that the relationship in Arrow’s (1962) “replacement effect” is reversed. As the number of market competitors increases, and the expected benefit of the innovation grows, the probability that the regulator is persuaded to approve the innovation and that the innovation makes it to market can decrease. We relate our finding to the regulation of AI and other innovations, and we explore institutional mechanisms that can alleviate the political failure that we identify.