Will the EU’s Digital Markets Act undermine innovation?

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BrusselsReport.eu
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By  Robertas Bakula and Dr. Guoda Azguridienė, researchers at the Lithuanian Free Market Institute

The European Commission, European Parliament, and Council are currently busy negotiating the EU’s so-called “Digital Markets Act (DMA)”, a proposal aimed at curtailing the supposed anti-competitive behaviour of big online platforms and create a level-playing field for everybody in the digital market. EU legislators hope that new rules will invigorate the technological sector in Europe.

They are right that EU member states are losing the innovation game. Only a single European company (Siemens) has made it into the top 20 of innovative firms, which is dominated by American and Chinese companies. It is therefore vital to take a closer look at the reasons for that.

Unfortunately, the impact of the current EU proposal, which is likely to affect every player in the European market may turn the tides in a direction opposite to the one aspired for by the European Commission. We explain this in detail in the Lithuanian Free Market Institute’s new study “Digital Market Act: Competition, Private Property, Innovation and the Interests of the Users“.

The DMA targets large online platforms. At the core of the act is the concept of a “gatekeeper,” a concept which refers to platforms that have “a significant impact on the internal market” and that operate as an “important gateway for business users to reach end-users” and enjoy (or are projected to secure) an “entrenched and durable position.”

Companies which fit these vaguely defined criteria, under the interpretation of the regulator, will be assumed to behave anti-competitively. In a bid to help smaller enterprises, the DMA will ban or mandate certain business practices of these so-called “gatekeepers”.

For example, Operating System (OS) providers like Apple and Google will be forced to allow consumers to use third-party apps or app stores without approval. Shopping platforms like Amazon will be prohibited from privileging businesses that are using their ancillary services, like “Fulfilment by Amazon.” Search engines like Google will need to share search data with competing engines. In other words, platforms will need to surrender their competitive advantage and business models to continue operations, all under the threat of massive fines.

The DMA is built on wrong assumptions

EU legislators think that such measures will benefit consumers, assuming this would increase the number of alternatives online. That, however, is a misconception of consumer preferences. Users are not interested in maximizing but in optimizing choice. Too much choice can actually lower consumer welfare.

Filters, clear structures, pre-installed software, default settings, priorities and rating – all of the so-called “limitations” which platforms impose are, in fact, the rescue ships in the vast ocean of the internet. Instead of constituting an “abuse of power”, these are on the contrary services that users benefit from.

The size of the platform is another crucial part of that package of benefits for consumers. Since platforms provide advantages of a large network economy, their size is intimately connected with their success. When EU legislators assume platforms to be bad only because they are big, one question is left ignored – how did they manage to become big? The answer of course primarily by out-competing their predecessors with what consumers have considered to be a superior service.

The DMA threatens to throw up hurdles to innovation

Competition is only a means to an end, not the end in itself. There is no such goal as to compete more. In an unregulated market, companies invest, innovate, and improve to win the competition and attract consumers. Yes, the most successful ones achieve a “durable position.” But even then, they need to keep up their game and look out for existing and potential competitors.

History teaches that competition and innovation in the market are unpredictable. In the early 20th century, people assumed Standard Oil to be an immovable “monopoly.” Nobody could have predicted that Thomas Edison would outwit John D. Rockefeller with his lightbulb. More recently, Nokia controlled almost 50% of the mobile phone market. Who could have known that Apple’s and Samsung’s developments of a rectangle with a touch-screen would bring the dominant mobile giant into obscurity so fast? In both cases, the disrupting innovation could not have been foreseen or planned.

One thing, however, can be predicted. Under the rules proposed by the EU’s DMA, potential competitors and innovators would face the same regulatory burden when and if they become large and successful enterprises. As a result, incentives to take risks and challenge the market status quo would be significantly reduced.

Unfortunately, DMA’s impact assessment only wishfully projects positive outcomes while neglecting these negative consequences altogether. This is because the political perspective dominating the discourse fails to consider how innovation and technology are actually created. The DMA overlooks peoples’ motivations to pursue innovation, and in this way, the EU may bring the digital market to a halt instead of invigorating it.

The DMA’s ex-ante approach lifts the burden of proof for regulators that there is a problem

The kind of ex-ante regulation we witness with the DMA is actually a significant break from the standard competition policy approach. It signifies a shift from the case-by-case analysis whereby companies are punished for proven violations.

Instead, regulators will decide which companies fit the definition of the “gatekeeper” and impose restrictions or fines accordingly. No proof of anti-competitive behaviour is being required. If there was ever an example of disregarding the principle of the presumption of innocence, this is one. Ex-ante regulation punishing certain activities will propel innovators to escape the consequences and therefore slow down rather than encourage changes in the market.

Matt Ridley, a prominent British science journalist and businessman, has described innovation as a child of freedom. The matrix of the size, number, and actions of market participants under spontaneous competition cannot be described ex-ante. They are not known and cannot be known in advance. If it is the EU’s goal is to exhilarate the digital market, it should rethink which conditions are necessary for an innovation-friendly environment, not take it upon itself to plan something that cannot be designed.

There are numerous sensitive issues around digital service development. Nevertheless, politicians must put aside emotions and biases before coming up with regulation. Otherwise, they risk sacrificing foundational social institutions like property protection, the presumption of innocence and consumer-driven competition.

 

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