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Globalizing European Internet Regulation Will Not Necessarily Benefit European Companies

· March 11, 2015

Günther Oettinger, the European Commissioner for Digital Economy and Society, recently gave a keynote address at the #Digital4EU Stakeholder Forum, in which he discussed the importance of a Digital Single Market in Europe and uniform Internet regulations.  He also spoke of the need for Europe to catch up in digital innovation.  Although I plan to address some controversy in the remarks, it is important to note that much of what Oettinger said was on target.  Streamlining digital rules across the 28 member states of the European Union and ensuring that Europe produces (and attracts) more programmers and IT experts will go a long way to making Europe even more competitive in the digital economy.  (I have also discussed some other issues not addressed by Commissioner Oettinger, which would also go a long way into making Europe more competitive.)

On the more worrying side, Oettinger’s speech veered fairly overtly into jingoistic territory:

The Americans are in the lead, they’ve got the data, the business models and so the power… They come along with their electronic vacuum cleaner and suck up all the data, take it back to California, process it and sell it as a service for money.

This is not surprising.  Politicians playing to a domestic audience is par for the course.  Furthermore, consumers and innovation across the world benefit from more competition, whether it comes from Silicon Valley, Berlin or Beijing.  Besides a stylized version of how Internet companies actually operate, what was misguided is the notion that using the size of European markets (the EU is the world’s biggest economy) to drive companies to adopt European regulatory standards as the de facto global standard is going to benefit European companies (whether they benefit consumers is an entirely different matter).  This was an implicit assumption underlying Oettinger’s remarks, and was made explicit in other commentary from top European politicians:

Still, said Jan Philipp Albrecht, chief negotiator for the European Parliament on the EU’s new data protection law, “If you can achieve…a standard [globally] that is somehow near…your own, then this is an advantage.”

The Wall Street Journal surmised the takeaway from this series of statements as:

Their hope: As rules such as the right to remove Web links to personal information spread, European companies would get a leg up in the next era of Internet commerce.

But is this correct? To answer that question, it is helpful to break down this line of thinking into two questions: (1) whether large markets can drive regulatory norms, and (2) whether high levels of regulation would advantage European enterprise.

Can Large Markets Drive Regulatory Norms?

It is understandable why European regulators might think that setting “higher” regulatory standards could drive major Internet companies to adopt European rules globally.  The European market is huge and it is logistically difficult for Internet companies to comply with multiple sets of rules governing their products and services given the inherently global nature of Internet infrastructure.

There are analogues in other industries.  In the United States, California has used its position as the U.S.’s largest economy to push higher emission standards.  Given that automakers had to comply with California’s laws to sell their products in California, this de facto raised the national bar for emissions across the country and muted carmakers’ opposition to national legislation raising emission standards.  Another example of this phenomenon can be found in textbook standards in Texas.  In Texas, the State Board of Education — a relatively unknown group of officials who are selected by an election “practically devoid of voters” — gets significant editorial control of what textbooks can be used by Texas students.  Because religious conservatives on the Board maintain peculiar perspectives on history, science, religion, and geography, textbooks sold within the state must either parrot or tiptoe around these idiosyncrasies.  Given the size of the Texas market, and the cost of printing different versions of the same textbook, book publishers are loathe to fall outside of Texas’ approved content.  The result: much of the rest of the countries’ textbooks are compliant with Texas’ standards.

So, at least in that regard, there is some credibility to the theory that European Internet policies could become the de facto global standard.  This certainly isn’t inevitable, and many worry that instead of becoming a de facto standard a balkanized Internet could emerge, but, for the purposes of this argument, let’s assume that it is plausible.

Would High Levels of Regulation Advantage European Enterprise?

The second part of the argument, that globalized European Internet rules would advantage European companies, sounds facially reasonable.  However, the logic behind this argument is superficial and flawed.  Simply because the rules are European, it does not follow that European companies will have a leg up.  For European companies, the content of the rules matters much more than where they came from.  If the concept of “higher” regulatory standards leads to hard-to-comply-with rules, then European companies will likely face a harder time disrupting current incumbents.

For the sake of argument, let’s assume that the European Union passed a set of Internet regulations with high-regulatory compliance costs.  Economic literature is clear that high-regulatory compliance costs are more easily borne by incumbents and serve as a barrier to entry for new entrants, especially small new entrants [see here, here, and here for a few examples].

This dynamic is harmful for two interrelated reasons.  First, startups and potential competitors are disportionately harmed.  Intuitively this makes sense.  Companies like Facebook, Google, and Amazon may expend considerable resources complying with burdensome regulations, but they have a phalanx of lawyers, lobbyists, and policy specialists to navigate this terrain.  A startup with a good idea has limited funds, little institutional or political expertise, and even fewer lawyers.  Therefore, while a highly regulatory regime cuts into the profits of incumbents, it often proves terminal to new entrants.  Second, and beyond the scope of this article, but worthy of note: high-regulatory barriers to entry also make incumbent firms less efficient by (a) diminishing the competitive threat of new entry and (b) consuming more resources to comply with regulations.

Why GSM Doesn’t Tell Us Anything About Levels of Regulation

In describing the hope that internationalizing a European regulatory regime would promote European competitiveness, several European officials (including the European Parliament’s chief data protection negotiator, Jan Philipp Albrecht) analogize to Europe’s success in globalizing the mobile-communications GSM standard around the world:

[Albrecht] and others point to the EU’s success in exporting its GSM technical standard for mobile communications in the 1990s. That technology now is widely used by phone makers in Europe, the U.S. and China.

It is an illustrative example, but not for the purposes that Albrecht and others intend.  Unlike a regulatory system, technological standards increase competitiveness by lowering barriers to entry.  Standards foster competition, and ease market entry, by making it easy for all companies to build to that standard or incorporate it in their products.  In fact, the rapid spread of the Internet is attributable to easy-to-use technical standards.  And in the case of GSM, European companies had a first-mover advantage, and therefore benefited from the global adoption of the European standard.  This is not necessarily the case in the regulatory world.  In regulations like Europe’s ‘right to be forgotten,’ it is non-European companies such as Google, Yahoo! and Microsoft that have a first-mover advantage in regulatory compliance.

To illustrate the point that higher entry barriers lead to more stagnant markets with less disruption (and less opportunity for new entrants), one could look at the pharmaceutical industry.  (Now, there there are good reasons why we impose higher regulatory burdens on manufacturers bringing drugs to the marketplace, as opposed to more mundane goods, but that is not relevant to this discussion.)  Eight of the top 10 global pharmaceutical companies (as measured by global revenue) can trace their roots back to the 19th Century.  None is younger than 40 years old.  Certainly, in Pharma, other barriers to entry exist, such as the high-cost of R&D, but lengthy drug approval procedures and managing a complex system of global intellectual property laws consume a vast amount of resources, thus making new entry highly unattractive.  The result is less disruptive change in the sector.

Luckily for competition, the Internet is not pharmaceuticals.  The technology and global standards underpinning the Internet create dynamic competition fueled by low barriers to entry.  This phenomenon has turned the phrase “started in a garage” into a cliché.  As I have noted in a previous blog post:  “[o]n the Internet, consumers can flock to the best product or service en masse almost instantly. This means the best product or service often quickly gains impressive market share. However, the same dynamics that precipitated the rise of companies like Google and Facebook also place extreme competitive pressure on them.”  Remember when MySpace ruled the social media world and Yahoo! had “won” the search engine wars?  Point being, on the Internet market share is not as “durable” as it is in industries with higher barriers to entry.

Disruption, not Regulation, is Europe’s Path Forward

It is true that Europe got off to a slow start in Internet innovation for many of the reasons that Oettinger alluded to in his speech.  It is also true that none of the top 10 Internet brands are European, as Commissioner Oettinger notes.  However, there has never been more hope for Europe to burst into the global tech scene in a big way.  Given the dynamism and disruption that define technology markets (especially the Internet), top companies and big market shares do not last long.  In fact, big market shares often prevent companies from adapting to a quickly changing market.  Low entry barriers mean that nimble startups enter the market and often surpass the giants as they can more easily respond to changing market conditions because they are not tied to legacy revenue streams and business models.  And this is where Europe’s hope lies.

All signs point to a European market that is moving in the right direction.  As one prominent venture capitalist noted in the Wall Street Journal, “the outlook for European technology has never been more positive.”  At this years Consumer Electronics Show in Las Vegas, I thought I had gone to sleep and awoken in Paris when I went to get my morning bagel and coffee given the the number of people speaking French in the lobby.  I was not alone.  Nearly a quarter of the startups at CES were, in fact, French.  (Also, note Ryan’s recent DisCo blog post on Estonia’s thriving tech scene.)  Furthermore, and perhaps running counter to common perceptions, Europe has been very successful in the last decade at producing “unicorns” — tech and Internet companies valued at more than $1 billion dollars.

That is not to say that Europe, whose future tech competitiveness is premised on the rise of smaller tech companies and startups, would not benefit from a consistent regulatory standard across the Digital Single Market.  It certainly would, as it would be easier for European companies to scale on their own turf and then expand globally.  However, if European Internet regulations are onerous to comply with and raise significant entry barriers for startups, then — unfortunately — Europe will actually be shooting itself in the foot.  The provenance of the de facto global Internet regulation is of little import.  As noted Internet scholar Tim Wu once stated, “no one has ever conceived a better way of scotching competitors than to make them comply with complex federal regulation.”  Whether global Internet rules and regulation originate in Washington, Geneva, Brussels or Beijing, high regulatory barriers will only serve to entrench current incumbents and shield them from upstart competition.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.