Policy Uncertainty and Technological Innovation^'^ · Policy Uncertainty and Technological Innovation^'^ ALFRED A. MARCUS Battelle Science and Government Study Center Without certainty

Academy of Management Review 1981. Vol. 6. No. 3, 443-448

Policy Uncertainty andTechnological Innovation^'^

ALFRED A. MARCUSBattelle Science and Government Study Center

Without certainty about government policies, business decision makers areunable to assess risk and opportunity and make the trade-offs necessary forinvestment in new technologies. Different policies (R&D, health and safe-ty, economic regulation) have different effects, depending on type of in-dustry and size of firm. Because there are no established standards for judg-ing industry performance, it is difficult to know whether policy uncertaintyis simply a rationalization for not innovating or whether there is a cause-and-effect relationship between policy uncertainty and technologicalchange.

There is abundant anecdotal evidence about therelationship between policy uncertainty andtechnological innovation in energy and energy-related industries. Cogeneration, a process wherebyindustrial waste heat is used to generate electricity,is both technologically and economically feasible,but one of the barriers standing in the way of itswider adoption has been uncertainty about statepublic utility commission rate and licensing regula-tion [Hatsopolous, Gyftopolous, & Widmer, 1978;Senate Subcommittee on Energy Conservation &Regulation, 1977]. Similarly, the use of compositefuels made of pulverized coal has been held backbecause of uncertainty over interpretation of cleanair laws [Leonardi, 1978]. Conversion of industrialboilers from oil to coal has been delayed for thesame reason [Senate Committee on Interior & In-sular Affairs, 1975].

'My thanks to Paul Hammond, Samuel Doctors, and CharlesStubbard for their help in preparing this article.

'The research leading to this article was supported in part by theDivision of Policy Analysis, Department of Energy.

ly the Acadumy of Management 0363-7425

William A. Johnson [1976] goes so far as to arguethat policy uncertainty was the main reason theenergy crisis began: the petroleum companies didnot invest in new refinery capacity because of uncer-tainty about federal energy policy—in particular,the possibility that Congress might enact punitivelegislation and the Department of Energy mightissue inconsistent and poorly conceived regulations.The oil companies have argued that the prevention-of-significant-deterioration (PSD) policy in the 1977Clean Air Amendment has jeopardized syntheticfuel developments, and that oil shale and pipelinedevelopments have been delayed because of uncer-tainties over interpretation of the 1970 National En-vironment Policy Act (NEPA) [Nandini, 1978],

The anecdotal evidence provides many examplesthat energy companies are concerned about policyuncertainty. In the same vein, the Carnegie—MellonInstitute Regional Energy Policy Study [1977] foundthat many firms in Allegheny County did not gobeyond energy-saving housekeeping conservationchanges because of uncertainty about governmentpolicy. Likewise, the work of Knight, Kozmetsky,

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and Baca shows that industry in general viewsuncertainty about government regulation as a bar-rier to technological change [1976].

The evidence from these sources suggests thatwithout certainty about government policies,business decision makers are unable to assess riskand opportunity and make the trade-offs necessaryfor investment in new technologies. However, moreresearch is needed to determine whether uncertaintyimpedes business with respect to all governmentpolicy or only some government policy; whetheruncertainty impedes all firms and industries or onlysome firms and industries; and, particularly,whether it is simply a rationalization for decisionsnot to innovate or whether there is, in fact, a simplecause-and-effect relationship between policy uncer-tainty and technological change.

In the remainder of this article, I will deal withthese issues. First, I review the literature linkingpolicy and innovation. Then I place the policyuncertainty/innovation relationship in the contextof the "ecology of innovation" literature.

Policy and Innovation

Many studies have stressed the importance ofgovernment policy as a determinant of technologicalchange. The specific findings of these studies havediffered, however, owing to different definitions ofinnovation. Innovation is a slippery concept. For in-stance, it has been defined by economists as the ap-plication of an invention, or the adoption of a newtool or concept; but patent attorneys consider it tobe the discovery of a tool or concept and not itseventual application [Kelley & Kranzberg, 1975].

In this article, innovation will be viewed as the in-troduction of new practices and methods, as thereplacement of similar but less efficient inputs in theproduction process or outputs in the product mbc[Rosenblum, 1975; Warner, 1974]. Innovation canbe either a hardware change (a change in product,plant, or equipment) or a software change (a changein ideas, processes, or systems). Points to considerwith respect to such changes are percentage of rele-vant firms adopting, rate of adoption, and efficiencyof use. (Adoption is frequently accompanied by dif-fuse minor changes that are largely unrecognizable,as well as by specific, identifiable large-scale

changes.)Different government policies will affect innova-

tion differently, depending on whether it entails in-put or output, software or hardware, how manyfirms have adopted it, and so on. Unclear interpreta-tion of provisions in laws, such as the Clean Air Actor the National Environmental Policy Act, can beexpected to delay the adoption of innovationbecause of the difficulty firms will have assessingrisk and opportunity. Braeutigam [1979] posits thathigher discount rates and procedural cost lead todecreased innovation. The discounted present valueof future revenues must exceed the discounted pre-sent value of future costs [Eads, 1980, p. 52].Regulatory uncertainty makes this calculation dif-ficult.

Different Policies, Different Effects

Akel and Doctors [1973] studied the effects offederal space and defense R & D policy, and foundthat effects were selective, "being highly concen-trated in just a few industries and among the largestfirms in those industries." The effects of R & Dpolicy were likely to vary according to the type ofindustry and size of firm.

Studies of the effects of patent policy on innova-tion examine what can be considered another aspectof R & D policy [Noll, 1974; Trozzo,& Kitti, 1976];other studies envision government policy in terms ofregulation. Utterback, Allen, Holloman, and Sirlou[1976], for instance, make the distinction betweenregulatory constraints on the innovation-makingdecisions of the auto, textile, and chemical in-dustries, and on the innovation-making decisions ofthe computer and consumer electronics industries.They find the constraints greater on the auto, textile,and chemical industries. Again, we find that regula-tion affects some industries differently from others.

"Regulation" has two meanings. It implies health,safety, and environmental controls as well as tradi-tional economic regulation. One view, such as thatfound in studies like Wardell's on the FDA [1974], isthat health and safety regulations stand in the way ofinnovation. Wardell observed that the FDA's increas-ingly stringent regulations on drug development con-tributed to a decline in the number of new drugsavailable on the U.S. market relative to the number

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available in some other countries. This finding thatregulation is a constraint for the drug industry isconsistent with that of Utterback et al. for thechemical industry. In contrast, Gerstenfeld [1977],who studied a different sample of environmentaland safety regulations, concluded that they were astimulant to innovation. Thus, whether health, safe-ty, and environmental regulations stimulate orretard technological change appears to depend onthe industry and the specific regulations. Anotherfactor, and an important one, is the definition oftechnological change.

The practices and methods that Wardell considersinnovations are not the practices and methods thatGerstenfeld considers innovations. Wardell meansnew products, Gerstenfeld means new processes.Environmental, health, and safety regulations mayimpede the introduction of new products, butstimulate the use of new processes. Magat [1980]holds that environmental regulations bias a firm'soverall technological advance toward abatementtechnology. He also holds that they may cause areduction in the firm's output technology innova-tions, although they "need not have this effect."

In the early 1970s, the Brookings Institution spon-sored a series of studies on innovation that dealtwith economic regulation, or as Brookings definedit, the regulation of competition [Capron, 1971].These studies examined the effect on innovation ofregulating industry structure, prices, and com-petitive practices. The overall conclusion was thatperformance of regulated industries fell "far short ofthe ideal and even of a reasonable target for publicpolicy." But the Brookings studies introduced asignificant caveat "that only in a few exceptional in-stances" can the inadequacy of performance bedearly documented. Evidence on how a firm or in-dustry could be more innovative if unhampered byregulation was hard to come by, for there were fewcases of no regulation or alternative forms of regula-tion to compare with existing practice in the case ofthe regulated industry [Capron, 1971]. Whenscholars hold that regulation stimulates or retardsinnovation, they have not resolved with consistencywhat standard should be used in judging industryperformance.

The Brookings findings were confirmed in otherstudies of economic regulation by Klein [1975] andLeibenstein [1969], who found that because

economic regulation eliminated business risk andrestricted the freedom of firms to change operatingmethods, it encouraged a corporate laxity that wasinconsistent with innovative behavior. However,Capron argued that reducing risk actually promotedinnovation. Other studies detailed selective effects[Gellman, 1971]. Montgomery and Noll, for exam-ple, after examining the available evidence on thetransportation industry, concluded that there was"too much innovation in air transportation,technologies using the highways and, perhaps,pipelines, and too little innovation with respect torails" [1974].

The National Science Foundation, in a report oninnovation and government policy, maintains:

Hypotheses about the influence of regulation on in-novation tend to be isolated, are sometimes in con-flict, and do not form a coherent theory with predic-tive validity. This fact is not surprising, given thewide range of market structure and technologicalconditions in the industries that are regulated in theUnited States, the wide variety of regulations af-fecting these industries, and the numerous in-fluences on technological innovation apart from theactions of regulatory bodies. [1976 pp. 19-20]

NSF advises not to expect general conclusions toemerge on the effects of government regulation ontechnological innovation, but to aim for "limitedconclusions at lower levels of aggregation, such aswithin industries, areas of technology, or types ofregulation" [p. 23).

The Ecology of Innovation

Policy, however defined—either as R & D, orregulation—is only one factor among several af-fecting innovation. Scholars from different fieldshave tried to explain innovation through theperspectives of their disciplines. Economists, for in-stance, have depicted the influence of economic fac-tors, particularly the role of market prices, relativefactor costs, and limitations of supply. Mansfield[1968] argues that the rate of adoption is a linearfunction of the profitability of employing the in-novation, the size of the investment required to useit, and other unspecified variables; Schmookler[1966] shows that intensity of technologicaldevelopment is directly related to growth in de-mand; Nelson, Peck, & Kalachek [1967] suggest that

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the speed of diffusion is positively related to thecompetitiveness of the industry or market.

At least one economist [Arrow, 1969] has alsopointed out that non-economic variables affecttechnological change. Arrow argues that efficiencyin the use or production of a novel item or techniqueincreases with experience within the firm; moreover,the development of science, the education ofengineers, and the availability of particularproblem-solving skills interact with economic deter-minants of technological change to produce resultssignificantly different from what one might expectfrom purely economic causes.

Behavioral scientists have applied a differentframework to the examination of technologicalchange. Because they look at the "innovativeness"(potential for innovation) of firms or industries,they require more dynamic and complex measuresthan economists, who usually seek to explain in-novation that has actually occurred [Rosenblum,1975; Warner, 1974]. Some behavioral scientistshave examined the effects of characteristics of topand middle management, such as personality at-tributes, interest, and training [Coleman, Katz, &Menzel, 1966; Mohr, 1969]. Others have examinedrelationships among innovators and imitators andthe relative importance of different channels of com-munication [Gray, 1973; Walker, 1969]. Still othershave looked at the relationship between technologyand the design of organizational systems or the in-fluence of structure [Wilson, 1966]. And somebehavioral scientists have investigated whether thepotential adopters of an innovation perceive itssignificant characteristics as profitable, prestigious,compatible with needs and values, and so forth[Rogers & Shoemaker, 1971; Zaltman, Duncan, &Holbek, 1973].

The diversity of perspectives for studying innova-tion has led some scholars to call for an integrativeframework. Warner, for instance, argues that:

Researchers . . . have made significant contributionsto the understanding of the dynamics of processes ofchange; yet the state of the art in diffusion researchis not equal to the sum of the parts. This is due inlarge measure to disciplinary parochialism: Scholarshave concentrated on those innovations, diffusionenvironments, explanatory variables, andanalytical methodologies which are most compati-ble with their particular disciplines despite the factthat diffusion is not a discipline-specificphenomenon. [1974, p.3O]

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The phenomenon of disciplinary parochialismleads Rosenblum [1975] to call for "a policy-orientedsynthesis, one built on a conceptual framework thatwould interlink current disparate traditions of in-quiry-" [p. 117]. A Georgia Tech group advocates an"ecology of innovation" approach, which wouldhighlight the role of social, cultural, economic, andpolitical factors, stress interrelatedness and interac-tiveness, and seek a holistic view of the innovationprocess.

The National Science Foundation has supportedmultidisciplinary studies that use what could belabelled the ecology-of-innovation approach. Forinstance, an NSF-sponsored study by Greenberg,Hill, and Newburger [1977] looks at the economic,technical, and legal factors involved in ammoniaproduction. Greenberg, an economist. Hill, anengineer, and Newburger, a lav^^er, make separatecontributions. Policy considerations are included,as are economic and technological factors.

Suggestions for Research

Although policy considerations may not be thecritical factor affecting innovation, they play an im-portant role. Public policies shape the environmentof the firm, and they affect other crucial variables:(1) economic factors, such as prices, factor costs,availability, growth in demand, and the com-petitiveness of an industry or market; (2) the pro-gress of research and development; and (3) channelsof communication. They also influence social andcultural factors. In accord with recent NSF-sponsored research, there is a need to combinepolicy considerations with other perspectives to gaina more holistic view of innovation. It is also clearthat these factors are not independent of each otherand their relative interaction and interdependenceneed to be better defined and quantified.

Most studies view regulation as affecting the rateor intensity of innovation. A few have shown thatregulation also affects the substance of innovation.Government-set airline prices, argues Caves [1962],have resulted in service-improving innovations.Similarly, Averch and Johnson [1962] argued, in aclassic paper, that there is a propensity amongregulated firms to develop capital-intensive innova-tions when regulation is based on return on invest-ment. These studies indicate that the character of in-

novation as well as its rate have to be investigated.Research is also needed to determine whether

regulators are more effective in fostering innovationas a by-product of one type of policy as opposed toanother — specifically, whether economic regula-tion—(which controls profit, price, and structure)or health and safety regulation (which controlsqualitative performance) is more conducive to in-novation. Another important question is how bothtypes of regulation can be used to stimulate and notretard technological development.

A Georgia Institute of Technology study thatreviews the current literature proposes making a"map" of institutions and public policies affectinginnovation:

This map would indicate the effect of each institu-tion and policy on innovation and overlaps andconflicts among them. Such information would helplocate specific areas where information is lackingand which need further study. [Kelly & Kranzberg1975, Vol. 1, pg. 117]

Institutional mapping could be used to track the ef-fect of policy on critical decision-making variables,such as price, industry structure, demand, the stateof knowledge in the area, the existence of com-munications channels, and the attitudes and opi-nions of managers.

Concluding Remarks

Further study of the effects of policy uncertaintyon innovation could make a significant contributionto policy development and ultimately to innovation.Decision makers need more than case descriptions ifthey are to cope effectively with policy uncertainty.Presently we know that uncertainty has selective ef-fects, and that it affects the substance as well as thetiming of innovation, but we are unable to judgehow fast or in what way new products or techniquesshould be introduced. There is need for an analyticalframework that will provide a taxonomy of thesignificant barriers to innovation that policy uncer-tainty imposes and of the incentives to innovationthat come from policies crafted so as not to bemisconstrued.

Three policy areas could be studied: R&D policy(including patent policy), health and safety regula-tion, and economic regulation. Examining the rela-tionship between policy uncertainty and innovationmay shed light on the continuing controversy overwhether regulation stimulates or retards innovation.Further investigations will probably confirm thatregulations have different effects, depending on anumber of industry and firm characteristics andpolicy attributes.

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Innovations and

Alfred A. Marcus is an analyst at the Battelle Science and Govern-ment Study Center, Seattle, and an Affiliate Assistant Professorin the School of Business Administration, University ofWashington, Seattle.

Received 10/23/78

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