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Abstract

This research explores and quantifies the downside of technological innovations, especially the negative externality of an innovation interacting with the stock of existing innovations. Using two novel datasets, I make a novel empirical finding that the varieties of innovation-induced risks (e.g. varieties of side effects caused by FDA-approved new drugs) is quadratic in the number of innovations (e.g. number of FDA-approved new drugs) that caused these risks. Based on this new empirical finding, I further develop a Regulatory Growth Theory: a new endogenous growth model with increasing varieties of innovation-induced risks and with a regulator. I model both the innovation-induced risk generating structure and the regulator's endogenous response. This new theory can help to interpret several empirical puzzles beyond the explanatory power of existing models of innovation and growth: (1) skyrocketing expected R&D; cost per innovation; (2) decreasing ratio of Qualified Innovations (i.e. Regulator-approved innovations) to the number of total patents and (3) exponentially increasing regulation over time. Greater expenditures on regulation and corporate R&D; are required to assess the net benefit of innovation because of "Risk Externality": negative interaction effects between innovations. Theoretically, this new "Risk Externality" effect counteracts the crucial "Knowledge Spillover" effect in the Endogenous Growth models. The rise of regulation versus litigation, and broader implications for regulatory reform are also discussed., Secondly, I propose a new theory of rational "Rush", emphasizing the quantity of rational over-investment in contrast to the theory of irrational price "Bubble". I illustrate an important friction when financing breakthrough innovations: non-excludability and spillover of uncertain knowledge due to imperfect IPR (Intellectual Property Rights, e.g. patent) protection. Facing a limited supply of new projects with uncertain return, investors make decisions about when and how many projects to invest. Investors' preemption motive will distort their incentives for patient learning about project return, thus inducing them to "rush in" to finance uncertain projects massively at a premature stage. A small positive news shock regarding the project return can greatly amplify over-investment and result in large social inefficiency. On the other hand, information externality creates free-rider motive, which can also make under-investment possible. Empirical finding based on sectoral Venture Capital investment shows that weak IPR protection lead to excessively high investment level and more procyclicality. Broader patent rights should be granted when the uncertainty of innovation is high, although the "Rush" prevention can induce more patent race at the early R&D; stage, i.e. Rush-Race shifting., Finally, I propose a Knowledge Theory of Regulation. Knowledge of innovation-induced risks is a public good. Therefore risk knowledge will be undersupplied if only through courts and private litigations. Compared to courts, regulators have their comparative advantage in acquiring and sharing new risk knowledge. Enlarging risk externality induced by growth and innovation accumulation will lead to faster expansion of regulation thanks to regulators' comparative advantage in risk knowledge acquisition.

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