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Regulatory Impact Analysis for the Regulation of Microbial Products of Biotechnology: Effects of the Final Rule on Innovative Activity

VI. EFFECTS OF THE FINAL RULE ON INNOVATIVE ACTIVITY

Both direct effects, defined here as the incremental burden or costs incurred by a facility to comply with regulatory requirements (such asincreased reporting costs and delayed product introductions), and indirect effects, defined here as a facility's response to the direct burden or costs incurred (such as shifts in the focus of research) must be considered in assessing the overall impacts of the rule on the biotechnology industry.(Footnote 1) This chapter examines the indirect or "hidden" effects of the rule on innovation. The chapter is divided into three sections as follows:

Section A presents a qualitative discussion of how therule may impact innovation;

Section B uses a simplified decision model to show howregulatory costs may affect the product developmentprocess and pace of innovation;

Section C summarizes some important considerations inconnection with assessing impacts on innovation.

A. The Final Rule's Effects on Innovation

The innovation question addressed in this chapter can be seen as a chainlinking the rule to the ultimate effects imposed by the rule on the nation'swelfare. The direct effects of the rule are to increase the cost and time todevelop new products. These direct effects, however, could spawn indirecteffects on the numbers of new products developed and the nature of thoseproducts. These indirect effects, in turn, can affect the economy as a wholeand the welfare of society.

1. Direct Effects

The direct effects of the rule arise in connection with the timeand expense associated with reporting to the federal government, plus the lesstangible cost effects associated with possible delays in bringing new productsto the market. Appendix F presents an assessment of the reporting costs thatmay be incurred on a per-product basis. These effects are expected to varywidely across different types of projects, with the highest incremental costsbeing for first-time products requiring extensive field testing. Costsassociated with delayed products are potentially even more variable, withhigher chances of a significant delay if a series of field tests is performed.

2. Potential Indirect Effects of the Final Rule on Innovation

Any indirect effects on innovation would most likely arise inconnection with industry's product development strategies. First, theregulations could influence choices between using naturally-occurringmicroorganisms or engineering microorganisms to perform a task. Since theregulations would generally not apply to natural isolates, firms may tend toavoid engineering microorganisms if natural isolates provide a suitablealternative (Bourquin 1990, Mondello 1990, Shields 1990).

Second, if a firm chooses to use microorganisms subject to the rule, theregulations may affect how those microorganisms are developed and applied. For example, one industry source mentioned that a modular approach might beamong the most effective approaches for bioremediation at a variety of sites. At each new site, the desired genes would be inserted into a microorganismisolated from the soil at that site. This would increase the chances ofsurvival in the climate and special characteristics of each new location. However, since a separate submission could be required for each host, somefirms may choose instead to develop a single product to be used at all sites.

Decisions regarding minor modifications in products could be influencedby the perception that potential delays in commercializing the product mayexist. Since field testing is frequently seasonal, regulation could affectthe scheduling of field tests or the number of field test locations.

While the indirect effects described above generally result in costavoidance strategies or potential delays introduced into product developmentschedules, a firm may find the regulatory process to be a mechanism throughwhich public resistance to a product due to misperceived risks may be reduced. In such a case, the costs incurred associated with the review process couldaccelerate a product's development schedule, thus mitigating the overall costimpact of regulation.

These potential effects may be acceptable in those cases in which theyreduce risk significantly. However, they would be undesirable in cases wheresociety may be deprived of useful low-risk products.

3. Links Between Direct and Indirect Effects

The nature and extent of innovation effects are difficult topredict and depend on the links between product development cost increases andchanges in product development decisions.

The basic reason to expect indirect effects is that the development ofcommercial products in the biotechnology industry is guided by the profitmotive. Since the rule would increase the costs of developing many productssubject to regulation, firms may find it necessary to re-examine the expectedreturn associated with a potential product.

The high degree of uncertainty surrounding both the potential forcommercial success of a biotechnology product in a particular market area andthe regulatory costs associated with its development make it impossible toestimate innovation impacts quantitatively. In addition, the extent to which

other factors may be involved in decision-making regarding product developmentis difficult to ascertain. Members of the regulated community may findweighing the financial risk of product development against potential returnsto be difficult in many cases, and may need to ensure that other factors areadequately considered prior to making any decisions regarding productdevelopment. For example, the ability of a firm to raise capital or to marketa potential product may override concerns regarding regulatory costs. Thepotential for regulatory review to reduce public resistance to products in thecase of misperceived risks could also be a major consideration. Thus, theimpact of regulatory requirements would be expected to be variable, and highlydependent upon product, market, and financial characteristics.

4. Links Between Indirect Effects on Innovation and Social

Welfare

The value of new products to society is measured not only by theircontribution to private profit, but also by their contribution to overallsocietal benefit. Unfortunately, information regarding the relationshipbetween a product's profit making potential and the magnitude of itscontribution to social welfare are not available; thus, no conclusions couldbe drawn with respect to the desirability or undesirability of innovationimpacts from a perspective of social welfare.

It is the intent of the rule, however, that only those microorganismswhich the Agency determines to pose the greatest uncertainties with regard topotential adverse effects be rigorously reviewed. This approach will ensurethat negative impacts on social welfare are minimized by shifting the greatestregulatory burdens to products which have the highest probability of resultingin excessive social costs.

B. Links Between Regulatory Burdens And Innovative Activities

In this section, a simplified decision model is presented to illustratehow responses to the rule might be formulated by the regulated community. Figure VI-1 shows schematically the wide range of possibilities potentiallyopen to a biotechnology firm, and the choices the firm might have to make inplanning whether and how to develop a biotechnology product.

The firm can be pictured as having a certain amount of capital, a numberof trained employees, and knowledge about the industry and potential markets. How it decides to proceed can be illustrated by its choice of one particularpath through the diagram from top to bottom. At each node, or branch point,the firm must make a decision until it reaches one of the endpoints shown inthe diagram.

Each of these branches will have certain advantages and disadvantagesassociated with it. In many cases, deciding not to develop any new productswill have the least potential uncertainty and risk. On the other hand, thereturns from this course could be relatively low, and there will be no chanceto build for the future. Branches involving the use of new techniques tocreate products offer very different risks and payoffs, with higher potentialgains in exchange for uncertainty and high costs.

The two decisions facing the firm -- whether to develop new products,and what types of microorganisms to use -- might in most cases be made throughan informal decision process. Still, the decision process should implicitlyconsider or reflect some critical underlying factors. The most importantfactors will involve projections of the costs of proceeding down each path,the expected returns or benefits at the end of each path, the timing of the flows of costs and benefits, and the degree of predictability or riskiness of the flows along each path.

Different firms might make different choices faced with the samesituation. Hence, generalizations on firm behavior should be avoided sincethis is case-dependent. Sometimes, a company has no real choice ofmicroorganism or area without a major reshuffling of resources. Often,however, a company is involved in both TSCA biotechnology and other marketareas, and could shift resources relatively easily from one area to the other. Many companies engaged in TSCA biotechnology activities also are involved inactivities not affected by the rule such as non-microbial chemicals, oil,food, and waste treatment, or medical and crop biotechnology. Hence, the mainoption for a firm wary of TSCA biotechnology regulations would seldom be lessinnovation as a whole, but rather other avenues of research not affected bythe rule. In some cases (e.g. medical biotechnology), these other optionswould themselves involve high payoff, high risk, and regulation that may bemuch more extensive than TSCA biotechnology regulation.

C. Summary of Considerations

This chapter contains a number of points that policy makers shouldconsider in assessing the rule and in choosing among options.

Delays in new product introduction, a reduced number of productmodifications during field testing, or product cancellation due toregulation all impose hidden costs on firms in the form offoregone profits. In some cases, these hidden costs may outweighdirect compliance costs.

The cases in which impacts are most likely to stimulatereassessment of product development goals would be those involvinglong delays in commercialization induced by the regulatory reviewprocess, or involving a series of reporting steps that imposesignificant costs at each stage. Due to the flexibility in therule, situations such as these can be avoided (and innovationimpacts reduced).

While regulatory costs are certainly one consideration in settingproduct development goals, other factors may be of equal orgreater concern in many cases. Such concerns could includeacquisition of capital and marketing ability.

Tailoring the regulatory process to shift burdens toward thosemicroorganisms associated with the greatest uncertaintiesregarding risk minimizes negative impacts, and may represent a netgain to society.

Negative impacts on innovations are not necessarily harmful,because not all innovations may be valuable enough to outweigh thecosts and risks they impose. The potential for harmful effectsfrom biotechnology innovations provided impetus for the rule.

In some cases where public resistance to products is based onmisperceived risks, regulatory review may improve innovativepotential.

1. * While the focus of this chapter is on the potential for innovativeimpacts to occur resulting from incremental regulatory cost increases,regulatory costs for many products will be reduced relative to current policy,due to the exemption provisions of the final rule.


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