How Regulation Can Be Good For Innovation

by Bradford Plumer | July 16, 2010

Steven Pearlstein has a good column in The Washington Post today about how smart government regulation can actually foster technological innovation. It's a useful counterpoint to conservative claims that a cap on carbon emissions will crush the economy and shunt us back to the Dark Ages:

It's been 20 years since Harvard Business School professor Michael Porter provided scholarly support for the notion that, rather than hamper economic growth and competitiveness, well-crafted regulation could actually promote it. ... His studies of specific industries also turned up numerous examples of new products and more efficient ways of doing business that came about only because companies and industries were forced to comply with rules.

Porter's musings, introduced in an article in Scientific American, have since spawned a cottage industry of researchers intent on proving or disproving his hypothesis. Its most controversial aspect was to suggest that profit-maximizing companies were ignoring opportunities to produce profitable new products or adopt more-efficient production techniques. ...

But subsequent research confirmed what some of us have long since discovered—namely that corporate executives can be stuck in their ways, averse to risk and unwilling to sacrifice short-term profitability for long-term gain. And as a result of these market "imperfections," sometimes a new regulation comes along that spurs innovation by forcing companies to look at things in new ways. That doesn't mean that regulation is costless, but it does suggest that, on an economy-wide basis, those costs can be offset by subsequent investment and innovation.

This is exactly the rationale that's frequently offered up in support of carbon pricing. Just having a policy in place, even a modest one, will force business leaders to start paying attention to their energy use and carbon pollution. Suddenly they'll discover that there's a whole heap of needless and costly waste in our energy system—as in, trillions of dollars in waste—that they've been ignoring all along. Then the innovations come flooding in. This is one reason why, historically, environmental regulations have always cost far, far less than either industry or economists predicted: New technologies invariably make cutting pollution very cheap.

I'd just add one point Pearlstein left out. A number of experts, such as Greg Nemet, have argued that bringing about all the innovations we'll need for decarbonization will require two things. On the one hand, you need proper regulations (or a carbon price), so that there's actually a market demand for clean energy and efficiency. But that, on its own, isn't enough. For a whole heap of reasons, companies tend to under-invest in R&D (partly because the benefits often spill over to their competitors—see here). So there's a case for ramping up government investment in energy research, too. As Dan Kammen has found, the number of patent applications in various energy sectors has risen and fallen in close conjunction with federal R&D spending in those areas. And, as my colleague Mark Muro likes to argue, this R&D component has tended to get short shrift in a lot of energy bills.

(Flickr photo credit: nyoin)

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