Do product market reforms raise innovation? Evidence from Micro-data across 12 countries

Abstract

How does policy affect innovation and the digital economy? We revisit how product market regulation affects innovation and develop a novel framework for thinking about digital regulation. Using new company-level micro-data across 12 countries between 1998 and 2012, this paper first estimates the effect of competition policy on innovation. We find that a standard deviation rise in standardized index of product market regulation is associated with a 1.03% decline in innovation activities. These declines are a result of product market regulation on the incentives to invest in in-house R&D and make the appropriate capital acquisitions, as well as of the effects of regulation on the cost of innovation activities. We then theorize on the effect of digital regulation on innovation and we empirically explore it on a sub-sample of the years in our analysis. We find that “protective regulation”, i.e., regulation that creates predictability and scope for markets to work, confers a positive effect on innovation, while “restrictive regulation”, i.e., regulation that endeavors to spell out negative behaviors, confers a negative effect on innovation. We also find that the digital regulation results are more sensitive to the content of regulation. We attribute this ambiguity to the fact that markers require an enhanced level of trust to be operative.