E-Privacy Regulations and Venture Capital Investments in the EU
As negotiations over the proposed new EU e-Privacy Regulation heat up, European policymakers are considering the broader implications for Europe’s economy. In this blog post Professor Anja Lambrecht of the London Business School presents her new research on the relationship between existing EU e-Privacy frameworks and venture capital investment in the EU. Professor Lambrecht’s study was first presented at the Center for European Policy Studies at the end of last year.
Firms in the digital economy contribute significantly to innovation by creating new products and services for consumers and business at impressive rates. Often, collecting and analyzing data allows firms to offer new and superior services. For example, location data from internet-enabled consumer devices like smartphones can be used to notify consumers of weather changes or emergencies in their area, or suggest restaurants in their vicinity. Consider also the multitude of online streaming services that learn a user’s preferences in order to suggest new artists, films, and books that might be of interest to them. The potential for innovation in the digital economy also means that investment in European technology companies is substantial. According to Atomico’s 2016 “The State of European Tech” report, tech investment in Europe increased to a projected $13.6 billion in 2016, up from $2.8 billion in 2011.
However, the collection and parsing of user data has raised concerns among EU public policy makers about user privacy. To address these concerns, the EU enacted the Privacy and Electronic Communications Directive in 2002 (amended in 2006 and 2009), which regulates, among other issues, the use of personal data and the use of “cookies” by websites and other services (cookies are the small packets of data that allow a website to, for example, remember a username and password between visits or store items in a shopping cart, as well as track behavior for the purpose of advertising).
But restricting companies’ use and collection of data may unintentionally hurt companies in the digital economy, and by implication, reduce investment into the digital economy. These concerns especially apply to firms that rely on the collection, analysis, or storage of large amounts of user data, such as in the online news, online advertising, and cloud computing sectors – sectors that are highly relevant to the online consumer experience as they encompass many of a user’s typical online interactions. For example, many consumers receive their news from online sources (spiegel.de, guardian.co.uk, among many others) that show relevant advertising to users and so earn advertising revenues – making it possible to offer consumers free access to content. Policies which limit the effectiveness of firms’ ability to use data for the purpose of showing relevant ads to consumers potentially harm online news providers by decreasing the precision with which relevant ads are displayed to consumers. Such a negative outcome may have a cascading effect on the online advertising sector as depressed revenues for ads may lead to declining investment in online advertising technologies. In the cloud computing sector, firms that provide analytics services may have to deal with more burdensome regulations with regard to using cookies to collect and process user data. In addition, firms serving telecommunications customers have to deal with requirements relating to data security and data breach notifications. These policies may lead firms to invest disproportionately into complying with governmental guidelines, decreasing their profitability and distracting management from a focus on innovation, or to forego serving this potential customer segment. In turn, reduced growth and profitability is likely to be reflected in lower investment into these sectors.
My research studies whether changes to EU e-privacy law starting in 2002 were associated with a change in the level of venture capital (VC) investment in the EU relative to the U.S. VC investment is a useful metric because it is indicative of early-stage growth and interest in a sector. Venture capital has also been shown in other studies to be related to both economic growth and job growth in an industry, and is therefore a good indicator of innovation.
My analysis suggests that in the EU, VC investments into these three sectors increased at a slower pace than in the U.S. after the passage of the 2002 EU e-Privacy Directive. Specifically, VC investment across these three sectors was between 58 to 75 percent lower in aggregate each year than it would have been if the EU and U.S. had maintained similar trends in investment after the third quarter of 2002. Note that the available data do not allow me to pin down the effect of the EU e-Privacy Directive separately from other factors that may be contributing to these differences (e.g., the differing rates of adoption of ad blocking software in the EU compared to the U.S.).
My results are in line with the view that policy makers face to some extent a trade-off between tighter privacy policies and VC investment. This seems important given that VC investment has been linked to job creation and innovation. Discussions are currently ongoing within the EU to introduce further restrictions on the use of data in the context of the proposal for Regulation on Privacy and Electronic Communications. To the extent that these rules contain provisions that may further limit firms’ access to and processing of user data, it is plausible that they may also affect the profitability of firms in online news, online advertising, and cloud computing, which can dampen VC investment in Europe.
Note: This research was funded by CCIA (Computer and Communications Industry Association) and supported by Google.