Oscar Guinea and Vanika Sharma / Feb 2025
Photo: Shutterstock
Growth and competitiveness have returned to the centre stage as Europe’s survival strategy. In January 2025, the European Commission launched its Competitiveness Compass establishing competitiveness as the key objective for long-term economic prosperity. It aims to boost competitiveness by prioritising innovation, decarbonisation, and security. However, what the Competitiveness Compass fails to account for is the inevitable economic trade-offs to achieve these goals.
The inability to recognise trade-offs has been a constant problem in EU policymaking. This long-standing issue also appears in the Draghi report, which forms the basis of the EU’s Competitiveness Compass. Draghi fails to draw the connection between the damaging effects of overregulation and the underperformance of Europe’s digital sector.
Recognising these trade-offs is crucial, particularly given the increasing role of digital technology in driving productivity. Consider Figure 1, which shows the percentage of firms with very high digital intensity and their corresponding labour productivity across economic sectors in each EU member state in 2022. The data suggest that economic sectors with a greater share of firms exhibiting very high digital intensity generally tend to achieve higher levels of labour productivity.
Figure 1: Percentage of firms with very high and apparent labour productivity across economic sectors, 2022
Source: Authors’ calculations based on Eurostat. Note: Apparent labour productivity values capped to 200 to eliminate outliers. 9 data points were deleted from the figure.
This is in line with several well-founded arguments on how digitalisation enhances productivity. For instance, digital advertising enables companies, particularly Small and Medium-sized Enterprises (SMEs), to connect with customers more effectively by reaching both domestic and international markets. This enhanced connectivity drives higher sales fostering firm growth and business specialisation, ultimately leading to greater productivity. Similarly, the Eurostat survey on AI usage across EU firms found that AI enhances firm productivity by improving processes, automating tasks, and helping to develop new products and services.
Digital regulation shapes the pace of digital adoption and diffusion. The volume and restrictiveness of regulation affect the extent to which firms can adopt digital technologies, for instance by limiting access to these technologies; reducing firms’ ability to use ICT-related intangible capital; or disincentivising firm growth, which in turn hinders the adoption of digital technologies. Between 2016 and 2024, the EU introduced an additional 833 pages, 758 articles, and 3,673 new restrictions in the field of data and privacy.
However, the primary effect of regulation lies not in the regulatory burden but its impact on digital endowments such as data. By restricting access to these endowments, regulations shape how firms develop comparative advantages and specialisations, ultimately influencing economic flows such as trade and investment. Figure 2 presents this conceptual framework.
Figure 2: Model for Understanding the Behavioural Effects of Digital Regulation
Some of these effects have been identified empirically. For instance, Article 5 of the General Data Protection Regulation (GDPR) restricts firms’ ability to combine data for purposes beyond their original intent. As a result of this provision, EU firms were forced to delete substantial amounts of data upon the GDPR’s implementation, while also hindering the creation of future data endowments. The ultimate effect was that, two years after the GDPR’s implementation, EU firms stored 26 percent less data on average than their US counterparts. Similarly, the Digital Markets Act (DMA) limits how gatekeeping platforms can combine endowments or assets, diminishing the usefulness and competitiveness of their services, and consequently shaping the comparative advantages and economic flows of EU firms.
These constraints on endowments undermine Europe’s comparative advantage, steering European firms towards non-digital activities. This is a real concern for Europe’s future economic prosperity, given that an increasing share of value-added in sectors where the EU currently leads such as automotive, machinery, and pharmaceuticals now comes from digital technologies. In other words, the restrictiveness of EU digital regulation may not only stifle Europe’s ICT sector but also undermine its industrial competitiveness by hollowing out a growing share of its future value-added.
The calls for regulatory simplification and reducing the regulatory burden in the Competitiveness Compass are a welcome step towards restoring Europe’s competitiveness. However, these efforts alone are insufficient. The European Commission must recognise that the Competitiveness Compass’s goals of closing the innovation gap and boosting productivity cannot be achieved without a fundamental rethink of the EU’s digital regulatory framework. One that incentivises, rather than hinders, Europe’s digital economy, the accumulation of digital endowments, and the diffusion of digital technologies.
