Ratcheting, Competition, and the Diffusion of Technological Change: The Case of Televisions Under an Energy Efficiency Program

by Tomomichi Amano and Hiroshi Ohashi

Overview — The diffusion of innovation in many markets is greatly influenced by the presence of policy intervention. Importantly, diffusion is further affected by the fact that firms often also have a say in affecting the implementation of policy. This analysis of the Japanese TV market suggests that firms may delay the introduction of more high quality products when there are across-the-board policy standards.

Author Abstract

In differentiated goods markets with societal implications, quality standards are commonly implemented to avoid the under-provision of innovation. Firms have clear incentives to engage in strategic behavior because policymakers use market outcomes as a benchmark in designing regulation. This study examines a unique energy efficiency standard for television sets, under which future minimum efficiency standards are explicitly a function of current product offerings. The setting illustrates firms' dual incentives at work: A firm better differentiates products under a looser standard but may want to induce a tighter standard if it can benefit from raising rivals' costs. These incentives drive firms to ratchet quality. We develop a structural model of product entry that illustrates how the regulator's standard setting rule affects a firm's product quality decision. Counterfactual simulations illustrate that ratcheting down was prevalent in this market and that incentives to ratchet up did not exist. The results suggest that in many commonly regulated markets in which firms share similar cost structures, firms are likely to experience incentives to ratchet down and delay the introduction of innovative products. The study highlights the importance of understanding supply side incentives, such as ratcheting, in designing and assessing policy.

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