Opinion: The EU’s digital lag

Facebook CEO Mark Zuckerberg speaks at a hearing of the European Parliament
May 22, 2018: Facebook CEO Mark Zuckerberg speaks at a hearing of the European Parliament in Brussels on the protection of personal data (source: dpa)

Google and Baidu; Amazon and Alibaba; Facebook and WeChat: these are some of the world’s digital giants. They are successful, innovative multibillion-dollar businesses. They are also all non-European Union companies. Why does the EU have no digital giants at all? Why do tech businesses refuse to bloom in the planet’s largest common market?

At first glance, the bloc’s digital lag appears mysterious. After all, the EU has a lot of positive factors going for it. Its top universities keep churning out brilliant people. There is plenty of private money for investment and an ultra-easy monetary policy. Many European countries have what they call digitization strategies that include government subsidies, regulatory exemptions and agencies ensuring public-private partnerships. There is even a union-wide program called the “digital single market.” Measured in terms of input, EU companies should be playing among the giants in the field. Yet, they are not.

One reason for this lag is, unsurprisingly, regulation.

Data protection

The EU's policy regarding personal data and data protection is contradictory. On the one hand, its central authorities seem to think that data can be used as a means of exchange. In antitrust cases, for example, the European Commission speaks about “paying with data.” This presupposes that data is the user’s, to be used freely. Once it has been used and exchanged, ownership would pass to its recipient, as money does. On the other hand, regulation prevents individuals from monetizing their data. It also limits how data can be used by acquirers, since it does not accept the transfer of ownership.

The Commission’s recently updated data protection directive is just one example of regulation curbing the supply of and the demand for data. By imposing restrictions on what data can be collected, the directive curtails supply. Demand is dampened by limiting what data can be aggregated and sold in down- and upstream markets by the data collectors. If demand and supply are constrained, there is little motivation for entrepreneurship. But users are even worse off. Since the use of data as a means of “payment” is curbed, there is less incentive for entrepreneurs to offer digital goods free of charge.

Antitrust

Antitrust is another area where the EU has crippled its own digital development. Here, however, the problem is not regulation. To the contrary, articles 101 and 102 of the Treaty on the Functioning of the European Union (also known as the Treaty of Rome) are better suited to a digital world than many of the provisions of the Sherman Antitrust Act in the United States, for example. The problems in antitrust arise because of an activist European Commission and an erratic Court of Justice.

Oblivious to the dynamics of digital markets, the EU taxes business models it does not understand as cartels or market-dominant entities


The Commission, oblivious to the technological and economic dynamics of digital markets, taxes most business models it does not understand as either cartels or market-dominant entities. The Commission especially downplays the contributions of market intermediaries, such as platforms, and disregards the fierce competition between systems arising from low barriers to market entry in the digital realm. In addition, the Commission uses antitrust for extraneous purposes such as trade protectionism or tax collection.

The Court of Justice corrects some, even many, of the Commission’s policy excesses, but by no means all. In addition, it has not always offered judgments combining sound legal doctrine with an understanding of business practice. Both of these EU institutions seem to miss a crucial point: most digital companies are small. They lack resources. Dealing with antitrust cases is challenging for any company, but it is especially troublesome for small businesses. The prospect of confronting the Commission’s activist verve discourages many entrepreneurs from entering the market altogether.

Essential facility

The EU’s current doctrine holds that any big digital company is an essential facility. Essential facilities are either monopolies, dominant market players or agents exploiting a “bottleneck” in the market. Under the doctrine, any enterprise found to own a facility essential to other competitors and to the market can be required to fulfill obligations that go beyond the firm’s legitimate business interests.

Essential facilities, while remaining private, are responsible for carrying out tasks for the further development of the whole market – not only of their particular market – including its agents. For example, essential facilities might be required to maintain supply, offer a predetermined level of service, grant access to competitors and even refrain from cross-selling. In other words, essential facilities are not allowed to exploit their entire market or are saddled with additional fixed costs that do not arise from their business models.

Folders with EU’s data protection directive
The European Commission’s mammoth General Data Protection Regulation restricts both the supply of and demand for digital data (source: dpa)

Many digital companies, however, are built up to become large. Often, economies of scale and networking are the only form of compensation for investments in technology and risks taken. Also, network effects especially benefit the users of digital goods. If there were only one recipient, email would not be used at all. It is beneficial because of the network of users and providers. The threat of being regarded as an essential facility by the EU has scared off many digital entrepreneurs. Why should someone invest if the investment is likely to become less valuable because of all strings attached by the essential facilities doctrine?

Tax regime

Let’s consider a hypothetical. Suppose an entrepreneur discovers a data-driven market, successfully navigates the EU's antitrust activism and avoids the essential facilities doctrine. His or her enterprise would still face headwinds. Most member states have discouraging tax regimes in general. In addition, EU authorities are now thinking about taxing digital businesses based on their revenues rather than their profits. True, the first proposals for this digital tax focus on large, non-EU multinationals. Entrepreneurs, however, are experts in planning for the future. They understand that once such a tax on revenue is introduced, it is only a matter of time before it is applied to all digital businesses.

Generally, and especially in the digital world, the EU and its members are more preoccupied with tax revenue than they are with innovation. This would not be a problem if tax competition were allowed to play out, disciplining high-tax countries and creating opportunities for low-tax locations. But there is ever more uniformization and centralization going on. This takes its toll on entrepreneurship.

Too many incentives

Despite all these problems, the EU often points to its strategy of incentives, subsidies and digitization as positive examples. Yet the more counterintuitive part of the explanation for the EU’s digital lag lies precisely here: these instruments hurt more than they help. In most EU countries, digital incentives aim at input, i.e. at helping some types of digital companies get started. However, they seldom measure the companies’ output. Therefore, rational agents try to maximize subsidies and other instruments by focusing on inputs.

If growing output threatens to make companies so “successful” that they would lose the input-based aid, their natural response is to curtail their output. In other words, many EU “digitization policies” incentivize digital companies to remain small and not improve their effectiveness and efficiency. Sometimes, such policies encourage digital companies not to be profitable at all.

The EU fosters regulation and political control over the digital world, while encouraging malinvestment


Even “low-key” instruments like regulatory exemptions for financial technologies or an easy pathway beyond antitrust for game developers can become tricky. Such preferential treatment just delays the entrepreneur’s exposure to real competition in real markets. These instruments make the digital companies less efficient and less proficient in acquiring market wisdom. At the same time, they create market distortions by discriminating against incumbents, which are already market-tested. It should not be overlooked that incumbents can innovate digitally, too. The EU regulatory regime usually identifies digital innovation with an entity or firm, instead of understanding it as a good or process that can happen anywhere.

Worst of both worlds

It might well be that the global push toward digitization is completely unsustainable. Ultra-lax monetary policies can lead to malinvestment. The money poured into digital and tech companies is often disproportionate to any value created. In addition, many digital goods, products and companies have been brought to life according to the principles of central planning or for the express purpose of bringing citizens and the economy under closer surveillance. The EU manages to combine the worst of both worlds. It fosters regulation and political control over the digital world, while at the same time actively fomenting malinvestment.

If the EU is on the wrong digital path, what should be done? In short: as little as possible. The bloc could encourage and increase tax competition, relax its antitrust activism, scrap the essential facilities doctrine, and allow people and companies to use and make money on data. Most importantly, the EU and its member states could let digital companies rise on their own merits in unfettered markets.

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