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IEA - Government risks stifling innovation in the digital sector, warns new research

Government risks stifling innovation in the digital sector, warns new research

This level of interference in the digital sector could undermine competition, reduce investment and deter UK start-ups.  

  • The government proposes to give a new Digital Markets Unit (DMU) additional powers to regulate firms in digital markets, in particular those firms deemed to have Strategic Market Status (SMS).
  • Firms that are deemed to meet these ambiguous and legally vague criteria will be bound to prescriptive codes of conduct, which regulate terms of business, self-preferencing and bundling. 
  • In certain cases, the DMU could force companies, which meet SMS criteria, to obtain approval for changes to their business models and technologies. Such invasive powers will establish a precautionary mentality to regulation and restrict dynamism in the market.
  • The Impact Assessment (IA) estimates the DMU will cost between £5 million and £25 million per SMS firm per year, mostly in reduced profits. This is likely to be a vast underestimate – the IA does not attempt to quantify the potential chilling effects on innovation, and possible DMU errors, which could cost firms considerably more.
  • However, the Competition and Markets Authority (CMA) already has the tools (which will be enhanced by concurrent reforms of the UK’s competition laws) to adequately regulate competition in the digital sector.
  • The proposals include significant powers of investigation and enforcement for the DMU, such as to search premises, interview individuals, and to impose court orders, fines and senior management liability. This could leave the DMU in the position of setting the rules, deciding to whom they apply and then investigating and enforcing them.
  • The authors believe there is no convincing evidence that the CMA cannot effectively regulate the digital sector using its existing powers. They suggest the government re-examine the unintended consequences of the proposed regulatory regime before bringing forward legislation. 

A new report by the Institute of Economic Affairs warns that proposals to introduce a new Digital Markets Unit (DMU), housed at the Competition and Markets Authority (CMA), will have dire consequences for innovation, investment and dynamism in the digital sector. 

The government is concerned that a small number of digital firms have gained an entrenched market position and are threatening competition. Although the CMA has the power to intervene in uncompetitive practices, the government believes the body lacks the tools to address the perceived unique challenge of digital markets. As such, they have proposed a new DMU with new powers to ‘promote competition’.

The DMU will be able to identify and regulate firms deemed to have Strategic Market Status (SMS). These are firms identified as holding ‘substantial and entrenched market power’. There is a danger that such vague criteria will give the DMU very wide discretion to decide which businesses it wishes to regulate. 

SMS firms will be subject to extreme legally binding codes of conduct which will set out business practices at individual firm level. In addition, the new regulator will have the power to pursue Pro Competitive Interventions (PCIs) which allow the DMU to mandate interoperability, third party access to data and ownership separation (breaking up larger firms).

The authors fear that such overbearing regulation will impose intrusive controls and ‘central planning’ reminiscent of the regulation of old-style utility industries. This will reduce innovation, investment and deter UK start-ups, as well as create security risks and harm consumers.

The scope of intervention in digital markets will increase substantially. Over the past decade, there have been 400 acquisitions by big tech platforms, but just a few were required to undergo formal clearance by the CMA (or EC). Had the proposed regime for referring mergers in digital companies been in operation during this period, the DMU would have had to review all 400, under its premise that its prior assessments had been too lax.

The paper recommends that the government halt legislation for the establishment of the DMU until a more rigorous impact assessment has been carried out. The authors suggest a DMU with such unprecedented powers is unnecessary; having greater expertise on digital markets in the CMA would be beneficial, but its existing powers are sufficient to oversee competition in those markets.

Victoria Hewson, IEA Head of Regulatory Affairs and co-author of the paper, said:

“There is a prevailing narrative that features of digital markets like network effects and scale mean that normal competition rules are not sufficient to prevent big tech monopolies from exploiting consumers. In fact, competition in the digital sectors is more vibrant than the government seems to realise and consumers benefit from highly innovative, often free services. Instead of trying to micromanage successful businesses the government should be addressing the barriers to entry faced by challenger firms from regulations like the GDPR.”

Dr Cento Veljanovski, IEA Law & Economics Fellow and co-author of the paper, said:

“The delay in giving the CMA new powers to regulate the tech companies provides the opportunity to reflect on how best to ensure competition in the sector. There is no need to rush to regulate badly as seems to be happening elsewhere in Europe. The CMA already has the powers to call big tech to book without creating a new layer of rules whose effects are unanalysed and unknown, and are very likely to impair competition and consumer benefits.”

Powering Up: How will the Digital Markets Unit affect competition and innovation? is under embargo until 00.01 Wednesday 6 July.

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