Ex Ante Versus Ex Post Regulation of Two-Dimensional Investments in R&D and Product Safety

Abstract We analyze a model in which firms compete to develop a technology involving possible accident risks under alternative liability rules (regulation modes). As a benchmark, we first consider a monopoly R&D market in which the monopolist is the sole developer, and obtain an invariance result that the monopolist chooses both the efficient investment in R&D and the efficient investment in its safety under both the strict liability rule and the negligence rule. Then, we consider a patent race model in which the first inventor gets the whole prize (monopoly rent) but is exposed to risks of accidents due to the technology. We show that firms have an incentive to invest for both R&D and safety too much in this patent race game under strict liability. Under negligence rule (regulation-first policy), they still overinvest for R&D but less severely, while they invest for safety efficiently. This model can be applied to regulation of AI innovation posing significant safety challenges.