A proposed model where new product has quality constraints, but market participants tend learn over time. Regulation balances information's role in reducing consumer risk versus reducing access to innovation. Using new revised data and variation between EU and US medical device regulations, we document patterns consistent with the model and estimate its parameters. Research found: (1) without information from testing, risk would severely inhibit usage; (2) US policy maximizes total surplus in our estimated model while the EU could gain 20 percent with more pre-market testing; and (3) more “post-market surveillance" could increase surplus 24 percent.
Most innovative and relatively new products are brought to the market because their makers believe in providing new value. However, with innovation often comes with uncertainty and the end product once falls into the hands of consumers, there is always some chance that the product will not operate as desired. The consequences of this failure range from consumer regret about product choice to death. When this risk matters for welfare, products often must go through pre-market testing and must be approved or certified by a formal body before entering the marketplace. Especially in concentrated markets, where private and public incentives may diverge significantly, the standards that the regulatory body imposes have the potential to fundamentally alter market outcomes by requiring testing that firms would not themselves undertake.
The potential welfare gain from access to new products is in tension with potential welfare loss due to the risk that those products may not be as effective as expected. The magnitude of this risk effect depends upon the mean quality level, the variance in that quality level, and the amount of information consumers possess.
The tradeoff between access and risk in regulating the market entry of new products is important in a variety of industries, and in particular in medical devices, where it is an active topic of policy debate in almost every country in the world. In this paper we develop a model with products introduced when quality is still uncertain, learning over time, and regulator (and manufacturer) decisions regarding product testing and market entry. We show that the empirical predictions of the model are borne out in market share data in the US and EU medical device markets and are consistent with the beliefs that the US regulatory environment is more restrictive than the EU. We then estimate the structural parameters of the model for use in welfare analysis of policy analyses affecting: (1) the length of clinical trials required before market entry and (2) observational learning after market entry.
Citation: Matthew Grennan, Robert J Town Regulating Innovation with Uncertain Quality: Information, Risk, and Access in Medical Devices doi: 10.3386/w20981
Received: February 2015 Revised: March 2016
Copyright: © Matthew Grennan, Robert J Town et al. 2016 all rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.
The authors declare that they have no competing interests.
Funding: Research reported in this is funded by Wharton Healthcare Management Department, University of Pennsylvania. The content is solely the responsibility of the authors and does not necessarily reflect the official views of Wharton Healthcare Management Department.