How Much Regulation is Too Much?
New research measures how French government regulation stymies innovation among smaller firms
Updated May 1
Worker protests in France. TikTok under fire in China and the U.S. EU countries continue to restrict big tech firms and even GPT. Will efforts like these stymie innovation and growth?
The Impact of Regulation on Innovation was studied by IDE Fellow John Van Reenen and his co-authors, as described in a recently published working paper. At a March 8 IDE seminar, Van Reenen discussed the timely topic and the research model the authors developed to quantify the impact of regulation on French firms. The key conclusion? Imposing restrictions on firms with more than 50 employees creates disincentives for businesses to grow and innovate because they see regulations increasing their costs and reducing profits.
While there’s general agreement that innovations drive new opportunities, improve efficiency, and spur economic growth, worker protections and open, competitive markets need oversight.
Van Reenen said a balance is needed when it comes to minimizing the effects of labor market regulations on economic performance. The researchers created a macro framework to examine the extent of French regulations on innovation among different sized firms. In particular, the framework studied the relationship between demand shocks and innovation using various datasets. Most notably, they found that French businesses avoid exceeding the regulatory threshold of 50 employees to evade taxes and other penalties. Read the paper here.
IDE content director, Paula Klein, asked Van Reenen to explain what prompted his research, why he mainly focused on France, and what this all means to global businesses. Here’s what he had to say.
IDE: Your research began before the latest events: Massive worker protests in France; TikTok scrutiny by the U.S. Congress, and ongoing efforts by the EU including a ban of GPT in Italy. What prompted your research and the scope of the study? Why focus on France?
JVR: The impact of red tape on the economy is always in the news. We decided to focus on labor regulation and innovation, and France is a country with notoriously tough regulation. Additionally, more than 85% of workers are covered by a union contract for collective bargaining purposes (closer to 100% now) even though less than 10% of French workers are in a union, so it was a natural place to start. If you can’t find an effect there, it’s unlikely you’d find it anywhere!
IDE: Describe your methodology a bit. You estimate that aggregate innovation is 5.8% lower due to regulation — how do you isolate the links to regulation?
JVR: There is a tsunami of labor regulations in France that hits firms when they get to 50 workers or more. We look at the universe of French firms and show what happens to innovation as measured by many things — such as patents — around the 50-person threshold. We found a big “valley” of low innovation efforts for firms before they reach the threshold, consistent with them not wanting to innovate and grow when they get to say 45–49 employees. Also, even when they are past the threshold, these mid-sized firms are slower to respond to market demand opportunities compared with much larger firms — all consistent with a chilling effect of regulation.
Based on the data, abolishing all the labor regulations and taxes would raise innovation and growth by 5.8%. For example, the French growth rate is about 1.6% per year. Without the labor regulation it would rise to about 1.7% (= 1.6 x (1.058)) per year.
IDE: To what extent does your framework apply beyond France — including countries like the U.S.?
JVR: We think our findings are pretty general and apply to the U.S. Some health regulations there, for example, kick in at 50 employees, so they may have similar effects.
IDE: Based on your research, will tighter government regulations, in fact, restrict innovation and growth? Which firms and industries might be impacted the most and why?
JVR: There is a risk of harming economic performance, but we aren’t condemning all regulation. There are often good reasons for the regulations that make it worth paying the cost. For example, if regulating big tech firms stops them from harming the innovation of smaller start-ups, then this is a good thing. Also, we found that the regulations mainly discouraged minor rather than radical innovation, so the costs may not be as large as is sometimes thought.
IDE: Workers and citizens often claim that they need protections, too, and that the overall economy and welfare are bolstered when labor demands are met and monopolistic practices are discouraged. How will all of these competing needs be resolved?
JVR: As noted, it’s all going to be context-specific. When thinking about reform, a cost-benefit analysis means looking at the benefits of the regulation along with the costs. When figuring out the costs, businesses often ignore the fact that there may be dynamic effects on growth and productivity; we argue that these shouldn’t be ignored.
IDE: What are the takeaways for business leaders in France and elsewhere?
JVR: The takeaway is that reforms to regulation, whether labor or pension law, can have substantial benefits. We know that there are high political costs to these reforms, but there can also be high economic benefits from greater growth, which in the long term is a good thing. It’s important to look at the big picture, but our study points to significant implications for small firms that can’t be ignored.
