The Impact of Safety Regulations on Externalities

Empirical analyses of product safety regulations have indicated that such regulations induce compensating behavior (also known as offsetting behavior) by the users of products that pose risks to their health. Many of these analyses conclude that such compensating behavior causes externalities to rise. In such cases, regulations reduce the loss suffered by the user of the good when a harmful event occurs, encouraging a moral hazard response which creates externalities for others. Other studies find that although compensating behavior mitigates the beneficial impact of safety regulations, such externalities do not rise. This paper presents a model suggesting that although compensating behavior always occurs in response to product safety regulations, a dichotomy exists wherein regulations engineered to reduce the typical loss suffered by individuals per accident (or loss event) will increase externalities, while regulations engineered to reduce the number of accidents (or loss events) will reduce externalities.