The Impact of Regulation on Innovation

The authors present a framework that can be used to assess the equilibrium impact of regulation on endogenous innovation with heterogeneous firms. The authors implement this model using French firm-level panel data, where there is a sharp increase in the burden of labor regulations on companies with 50 or more employees. Consistent with the model's qualitative predictions, the authors find a fall in the fraction of innovating firms just to the left of the regulatory threshold. Furthermore, the authors find a reduction in the innovation response of firms to demand shocks just below the threshold. Regulation reduces aggregate innovation by 5.7 percent.