Since childhood, my parents always expected me to be in a certain way, to behave in a certain manner and never gave me the opportunity to ask why. This thought might sound a little bit outrageous, but I am wondering whether too many institutions and such a well implemented rule of law will actually lead towards economic growth in the long run. During macroeconomics classes I was taught about how institutions and plenty of regulations all over the world will determine the world of tomorrow, but to what extent will this kind of approach determine a better world or better standards for all the citizens, ultimately determining economic growth?
Frankly, more institutions and an improved rule of law could make a change for the better in society. This could be the case, because returning to our classical economic growth model, institutions and the rule of law are the exogenous factors that will improve the current state of the society. For example, given the case of a developing country, such as Romania, it can be noticed that corruption is the “pillar” that halts the economic development of the country. The Romanian education system always rendered well-skilled people unhappy with the Romanian economic situation who left the country seeking for better standards of living abroad; implying a decrease in human capital, due to an exodus of highly intelligent people. Henceforth, a better implementation of the rule of law in this case would promote economic growth in the long run, determining the people to stay in the country and contribute to the human capital and labor force.
On the contrary, analyzing the Solow growth model, we can see that an important exogenous factor that influences the economic growth of a country is technological advancement. However, behind the scenes, how this technological progress is actually correlated to society? Well, innovation is a factor that determines technological advancement. The paper written by two Yale graduates “Regulation and innovation: approaching market failure from both sides” actually designs the interplay between innovation and regulation. Generally speaking, people tend not to dissect the nature of innovation, but, as the paper states, innovation is not a uni-dimensional term. Innovation can be seen from two perspectives: first, social innovation and, after that, market innovation. The economist Stewart argued that technical constraints encompassed by regulations could actually inhibit “market innovation” by leading firms to make extra expenditures to comply, giving rise to ex ante uncertainty as to whether innovations will meet regulatory requirements, and introducing delay associated with determining whether new products and processes meet such requirements.
Looking at the medical sector, one can remark that the pharmaceutical innovation has declined considerably in the past years. The actual cause of this situation, well stated in the previously mentioned paper, is represented by the “free ride” case. To be more specific, the regulations imposed by the government in order to protect the patent and cover the investments of the inventor may simply render a market failure, because they do not guarantee a fully covering of the cost implied by developing the medicine. Even though in the beginning they guarantee a monopoly over the market, after the stated period, the entrance of other competitors is no longer conditioned by the regulators. Therefore, a distinguishable drop in the initial price of the product can be immediately observed as a consequence of imperfect competition. This discourages the investors to further invest in innovation projects that will not guarantee a proper financing of all the costs involved in developing the product. Hence, even though regulations are intended towards protecting the inventor, they could be inefficient, because the R&D costs involved could never be fully covered and in the end less and less firms will perceive innovation as a feasible way to thrive on the market. Maybe, this way is feasible in the short run because at the current point it is enough to keep everything as it is in order to maintain our economic growth, but in the long run this will render a dynamic inefficiency, analysing the Solow growth model, since, in the absence of any sort of innovation, a way higher provision of capital will just move one country from the steady-state, promoting a higher rate of capital depreciation.
In conclusion, even though there is a clear link between regulations and innovation, I am still pondering over whether smoothing regulations will promote innovation in the long run or will harm the well-being of the society, as people will not benefit anymore from the safety that a powerful rule of law bestows.
1. Yafit Lev-Aretz, Katherine J. Strandburg (2019). Regulation and innovation: approaching market failure from both sides. Law & economics research paper; no. WPS 19-44. New York University School of Law.
2. Merrill Goozner (2015). Overdose: How Excessive Government Regulation Stiflfles
Pharmaceutical Innovation. DePaul Journal of Health Care Law.
3. David Clark (2016). Fighting corruption with con tricks: Romania’s assault on the rule of law. The Henry Jackson Society.