Motivated by China’s emergence as a high-tech leader, policymakers have recently shown renewed interest in a national strategy to enhance U.S. technological superiority and jumpstart innovation. Accordingly, a bipartisan effort in the Senate passed legislation to increase public investment in research and development, with a particular interest in advanced pharmaceutical and medical technology manufacturing and semiconductor production.
Yet this plan fails to recognize that more innovation will first require real structural changes to the environment for America’s emerging technology companies. It is no secret that regulations influence business activity. But my new research shows how technology startups are hindered by particularly heavy regulation in the high-tech and medical industries.
In a recent study published by the Fraser Institute, Paola Suarez and I studied about 15,000 tech startups headquartered in the United States from 2012-2019. We found that U.S. industries with more stringent regulations go hand-in-hand with higher technology startup failure rates.
We also find that more-regulated industries have fewer new technology startups. Specifically, a 1 percent increase in regulatory burden in an industry is associated with about a 2-percentage point reduction in technology startup birth rates.
Take, for instance, that the magnitude of regulations for the chemical manufacturing industry – which includes pharmaceutical and medicine manufacturing – increased by almost 100 percent from 2000 to 2017, as measured by the Mercatus Center’s RegData. Data processing and hosting, on the other hand, experienced a 37 percent increase in that same time period. Our study may help explain why we see more technology startups working on social media, clouding or web hosting services, and fewer working on pharmaceutical or medical technologies.
The connection between regulation and technology startups is also reflected in another study. As part of a John Templeton Foundation grant, my research team interviewed and surveyed more than 500 representatives from U.S. technology startups. Findings from our online survey suggest that about 70 percent of respondents believe they are operating in a heavily or moderately regulated industry, and of those, about 77 percent are in the medical technology or biotech space.
Indeed, fieldwork interviews with medical-related technology companies revealed the barriers to entry they face. They also revealed how the quantity and complexity of regulation leads to high compliance and operation costs — forcing many to shut down, change their ideas or margins of innovation or pivot into another industry with fewer regulations.
Medical technology companies are not the only ones that struggle. Other highly regulated tech industries are those in clean air technologies, airspace and financial services. Our study reports on how the cofounder and former CEO of an airspace service startup in California stated: “I wouldn’t [run a startup] again in a heavily regulated industry.” As a result of regulatory difficulties, the interviewee was forced to shut down the company. Several other executives directly stated that industry regulations hindered their ability to continue innovating and operating.
In contrast, representatives of many software startups openly discussed how it was relatively easy for them in terms of regulations. One founder and CEO of a business-to-business software startup in Boston stated, “No aspect of our software is regulated . . . We don’t really have a lot of regulatory concerns.”
Our survey also asked technology company executives about which level of government regulation had the most influence on their business. About 70 percent indicated that federal regulations mattered the most.
Both studies highlight how high levels of regulation discourage innovative activities — even in areas and industries where policymakers would like to see more growth. If federal lawmakers and the Biden administration want to encourage greater technological developments, in pharmaceutical and medical industries in particular, the answer isn’t complicated. They should seek to streamline or reduce regulatory barriers.
To promote innovation, the U.S. first needs to promote a better environment for innovators to grow and succeed.
Liya Palagashvili is a senior research fellow with the Mercatus Center at George Mason University, author of new research on “Exploring How Regulations Shape Technology Startups,” and co-author (with Paola Suarez) of “Technology Start-ups and Industry-Specific Regulations”