Depiction of European regulation of digital markets puts future innovation at risk

European regulation of digital markets puts future innovation at risk

The latest empirical evidence from Oxera shows that ex ante regulation could reduce expenditure in innovation by up to €3.4bn per year and stifle new services for consumers

In December 2020, the European Commission proposed new regulation known as the Digital Markets Act (DMA) in which it stated that “large platforms” should behave in a way that includes allowing the space for local players to innovate. New empirical research from Oxera shows that if the proposed reforms are not implemented carefully, they could have an adverse effect on innovation.

The empirical evidence supports previous Oxera research in this area. An Oxera report released in November 2020 (‘The impact of the Digital Markets Act on innovation’) highlighted three reasons why we might expect the measures proposed in the DMA to be damaging for innovation and growth in the EU:

  • European innovators are likely to have reduced incentives to strive towards becoming the ’next big thing‘ if regulation reduces the size of their prize;
  • European-only regulation could reduce the size of the market accessible to global innovators, reducing their overall incentives to innovate, or reducing their incentive to roll out innovations in the EU even as they may be introduced elsewhere, such as in Asia and the USA;
  • if larger (global) firms are restricted in their ability to innovate, smaller (local) rivals are unlikely to fill the gap, with a negative impact on European consumers—who would lose out through a reduction in services.

Oxera recently conducted a follow-up behavioural experiment seeking to bring new evidence of the impact of regulatory interventions, and to quantify the size of the November finding that ex ante regulation proposals could reduce the ability and incentives of firms to provide innovative products to consumers and businesses.

This experiment comprised a test group of international participants completing a practical online exercise that examined their willingness—as either a global or a local firm—to invest in innovation. It did this by asking them to choose how much to invest in a risky investment.

The results show that global players invested 8.6% less and local players 3.9% less when faced with the additional risk of having to share the benefits of innovating. The effect was smaller where local players are favoured, with a decrease of 2% in their investment, compared to no change for the global players.

The results suggest that if regulation such as the DMA holds back global competitors in order to give local competitors space to innovate, it could in fact reduce the competitive pressure on the local players and lead to less innovation by them.

The implications of these results could be significant for the levels of investment in research and development (R&D) in the European economy. In the ICT sector alone—a rough proxy for the parts of the economy most directly affected by the DMA—business enterprise R&D in the EU amounted to more than €40.1bn in 2019.

If the effects seen in this experiment were to occur in the wider EU economy, R&D expenditure for the ICT sector would reduce by up to €3.4bn per year. This reduction would lead to a material worsening in economic and social progress for European citizens. Taking account of the social returns to R&D expenditure highlighted in the economics literature, this could lead to a social loss of up to €6.8bn per year.

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