Tuesday, April 5, 2011

Why are Europe and the US so different in terms of regulation?

Europe and the United States have a different attitude towards many things, and one in particular is regulation. Think, for example, how Europe is adverse to genetically modified agricultural goods, while nobody really cares about that in the United States. Other examples abound, like the little checks there are in the American meat industry or the fact that helmets are not required for motorcycles in most US states. How can such drastic differences arise in countries that after all have a similar standard of living?

Johan F.M. Swinnen and Thijs Vandemoortele show that tiny differences in preferences can lead to large differences in regulation. To prove this, they develop a dynamic model with households, producers and political decisions on whether to allow a potentially objectionable technology. It implies that no regulation is imposed below some threshold level of preferences, and the technology is not allowed above that. This results is, I believe, mostly the consequence of the discrete nature of regulation here: either you allow or you do not. With intermediate levels of regulation, the story may be different. More interesting is the result that there is substantial hysteresis: once a decision is taken one way, it is very difficult to revert it even if preferences or the negative consequences of the technology change. This result is reinforced by the discreteness of regulation, but would most likely be present even without it. In other words, it is possible that tiny initial differences in preferences between countries can lead to large regulatory differences that cannot be overturned.

PS: As in much of this kind of literature, quadratic costs are imposed. I always wonder whether this functional form has implications on results, but nobody seems to care.

1 comment:

Anonymous said...

You hit the nail on the head. This "applied economic theory" literature is very frustrating because it keeps getting results that indicate something is possible, without ever going back and check whether the assumptions are reasonable. I have not looked at the paper, but I bet they justify all that just by citing other theoretical papers of the same ilk. Theory people: learn to make your models reasonable, and calibrate them!