János Tamás PAPP: Innovation vs. regulation: how the EU could hinder innovation in the online tech industry
Despite Europe having a fairly equivalent gross domestic product (GDP), population, and talent pool of educated people, large internet platforms (mostly U.S.-based digital businesses) have led the way in global tech innovation from Web 2.0 to artificial intelligence. The comparison between the European Union and the United States in terms of technology regulation illuminates two markedly different approaches, each with unique impacts on innovation. In the EU, a stricter regulatory environment aims to balance the power of “gatekeepers” and protect user privacy, but has raised concerns about potentially stifling innovation. Conversely, the U.S. has traditionally taken a more laissez-faire approach, fostering a robust climate of innovation while inviting criticism regarding unchecked power of tech giants and privacy concerns. The EU’s approach appears to be, in sum, “If you can’t innovate, regulate.”
One of the most prominent examples is the General Data Protection Regulation (GDPR), that came into force in 2018 to protect personal data and privacy rights of EU citizens. While the GDPR is indeed essential in addressing privacy concerns in the digital age, its stringent conditions for data handling and processing may impede tech companies’ ability to innovate. The GDPR, thankfully makes users’ data collection and analysis harder, but it also disadvantaged small firms and startups against larger companies. For example, companies may face restrictions in data mining, machine learning, and artificial intelligence development, areas where massive amounts of data are required for algorithm training and development. It led to a significant increase in the concentration of the web technology vendor market and decreased investments in European tech startups. Moreover, the enforcement of GDPR may inadvertently favor large tech corporations over startups. Compliance with the GDPR can be costly and time-consuming, thereby placing a significant burden on smaller firms with limited resources. This discrepancy might discourage innovative ideas and technologies from emerging, further contributing to the existing digital monopolies.
Other important pieces of legislation that could impede tech innovation are the recently adopted Digital Services Act (DSA) and Digital Markets Act (DMA). These regulations aim to prevent anti-competitive behavior by large tech companies and protect consumers from harmful content online. However, scholars argue that the strict rules may hinder innovation by discouraging companies from exploring new technologies and business models for fear of non-compliance. Both regulations are ex ante regulations, which in themselves can be a barrier to effective innovation. Ex post regulation is often implemented after a market failure or distortion. It generally happens once enough information is known and enough proof of harmful effects has been provided. However, sometimes, authorities try to spot issues before they arise. Ex ante regulation is predictive and subject to the bias of the regulators. Ex ante regulation instructs market participants on what to do, while ex post regulation instructs them on what not to do.
The DMA, meant to limit the power of “gatekeepers” in the digital economy, has been criticized for its broad definition of a gatekeeper and its potential to stifle innovation. It could inadvertently hinder service innovation, competition, and force companies to duplicate data infrastructures. It also raises concerns about limiting business model innovation and transformation, especially for traditional sectors adopting platform-based models. The regulatory goal of maintaining markets as open and competitive as feasible could be denoted by the terms like fairness (defined as equality of opportunity) and contestability (defined as lowering entry barriers on and around key platform services). When seen from that perspective, some argue for the contrary, stating that the DMA could be consistent with a modernized form of the ordo-liberal tradition that continues to guide much of EU competition law and in this regard, the DMA will not stifle innovation in Europe, but will instead work to increase its variety and ideally its level.
On the other side of the ocean, of course, they argue in defense of US companies, pointing out that the DSA include discriminatory clauses that are specifically directed at major U.S. platforms. For instance, the DSA originally classified 19 organizations as Very Large Online Platforms (VLOPs) or Very Large Online Search Engines (VLOSEs), of which 16 are privately held companies with headquarters in the United States, 2 are located in China, and just 1 is located in the European Union. A recent research by CSIS estimated the considerable economic consequences that U.S. and EU businesses would incur as a result of the DMA, DSA, and other new digital laws. The expected cost of compliance for U.S. service providers ranges from $22 to $50 billion. Additionally, according to CSIS study, there might be a 2% decline in US exports of services worldwide.
Andrew McAfee of MIT highlights the risk that the European Union’s proposed AI regulation would also stifle innovation. The regulations, which classify systems such as Duolingo’s English Test as high-risk due to their use of AI for personalization and grading, would impose extensive requirements on high-risk AI systems, even before initial testing. McAfee argues that these obligations will deter AI-using entrepreneurs and investors from focusing on high-risk applications, thereby slowing technological innovation in critical areas like education, hiring, and crime prevention. McAfee suggests that this upfront planning and oversight approach by the EU could lead to slower progress and growth, referring to the impact of the General Data Protection Regulation on venture investment and Google’s market share. He believes this approach may be contributing to the EU’s lag in the “second machine age”. He contrasts this with the “permission-less innovation” approach, which encourages a broader field of potential innovators, including those with less resources. The planned law has also been resisted by dozens of the continent’s leading business figures, who fear that it might harm the bloc’s competitiveness and cause an exodus of investment. They said in an open letter that the proposed law “In our assessment, the draft legislation would jeopardize Europe’s competitiveness and technological sovereignty without effectively tackling the challenges we are and will be facing.” They contend that the proposed regulations go too far, particularly when it comes to regulating generative AI and foundation models, the technology that powers well-known platforms like ChatGPT.
Another key element to consider is the regulatory uncertainty. Tech companies operate in an environment of constant change and disruption, which requires flexible and adaptable regulation. However, EU’s legislative process is relatively slow, and regulations often lag behind the pace of technological innovation. This delay and uncertainty can make it challenging for tech companies to plan for the future and make substantial investments in R&D.
More and more scholars argue that the regulatory focus should be on specific anti-competitive practices rather than on large platform operators. They suggest that preserving business model innovation should be a top priority and that regulations should focus on why ecosystems are competitive, not who is winning. Other suggestions include fostering market contestability in adjacent segments, and implementing a decentralized, data-driven accountability regulatory system. Some fear that without effective calibration, the DMA could distort platform industries and disadvantage small businesses and consumers who rely on these platforms. An alternate approach to regulatory design is needed, that builds general principles and leaves the interpretation of those principles to antitrust units. This would ensure that regulatory institutions can learn and adapt to the dynamic digital environment
In conclusion, while the EU’s legislative efforts play a crucial role in shaping a safer and fairer digital space, there are concerns about the potential adverse effects on technological innovation. There is a delicate balance to strike between the need for regulation and the freedom to innovate. Striking this balance will require ongoing dialogue and cooperation among policy-makers, tech companies, and the wider society to ensure the development of fair and innovation-friendly regulations.
János Tamás Papp JD, PhD is an assistant professor at Pázmány Péter Catholic University, Hungary and a legal expert at the Department of Online Platforms of the National Media and Infocommunications Authority of Hungary. He earned his JD and PhD in Law at the Faculty of Law and Political Sciences of the Pázmány Péter Catholic University. His main research fields are freedom of speech, media law, and issues related to freedom of expression on online platforms. He has a number of publications regarding social media and the law, including a book titled „Regulation of Social Media Platforms in Protection of Democratic Discourses”.