DP7280 Incentives to Innovate and Social Harm: Laissez-Faire, Authorization or Penalties?

Author(s): Giovanni Immordino, Marco Pagano, Michele Polo
Publication Date: April 2009
Keyword(s): authorization, deterrence, innovation, liability for harm, safety regulation
JEL(s): D73, K21, K42, L51
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7280

We analyze optimal policy design when firms' research activity may lead to socially harmful innovations. Public intervention, affecting the expected profitability of innovation, may both thwart the incentives to undertake research (average deterrence) and guide the use to which innovation is put (marginal deterrence). We show that public intervention should become increasingly stringent as the probability of social harm increases, switching first from laissez-faire to a penalty regime, then to a lenient authorization regime, and finally to a strict one. In contrast, absent innovative activity, regulation should rely only on authorizations, and laissez-faire is never optimal. Therefore, in innovative industries regulation should be softer.