Europe is lagging behind in the digital economy. The reason for this is not a lack of business ideas in the digital economy, the reason is that the current institutional and technical environment is not as conducive to growth as it should be. The Digital Single Market Strategy addresses some of these issues. But does it do enough? This blogpost reviews what has been achieved and what still needs to be done.
Why we need a Single Market for the Digital Economy
€415bn is a large sum of money. It’s roughly equivalent to the GDP of Poland. Or just a little less than four (!) times the estimated GDP increase in the EU through TTIP. €415bn is the estimate of the European Commission by how much the EU’s GDP would increase if the boundaries to digital trade between the member states were eliminated. But which are these boundaries? What is holding the digital economy back in Europe? What needs to be done to free the potential? This blogpost aims at answering these question and examines to what extent the Digital Single Market Strategy of the European Commission responds to these challenges.
Let’s go through the impediments to the digital economy first: One of the first concepts economics students are introduced is the “economies of scale”. The idea is simple: In many cases larger firms can produce more efficiently than small firms. Take the example of two farms, a large one and a small one: Suppose that on the small farm a tractor can work all the fields in two days while on the large farm it takes four days. Hence, with the same machinery, the large farm can produce double the output because it is more intensely used. Since the price for crops needs to cover for the price of the tractor, the large farm will be able to sell its produce cheaper than the small farm.
Economies of scale are particularly present in the digital economy. An internet platform currently serving 1,000 customers could easily serve 100,000 customers – all that is needed is a little more computing power and potentially logistics, if the platform involves handling physical goods. Hence the operating costs of a firm rise much slower than revenue. Therefore, it is an important prerequisite for successful digital businesses that they can reach many customers quickly. In addition, many digital business models are network based. The utility of a certain digital service – say Skype – increases with the number of people using it. The first customers of Skype did not have many other people to interact with. But as soon as Skype became widely distributed, it developed a great utility for its customers. Hence, in many cases of digital businesses, market leaders obtain a natural monopoly. In order to capture this natural monopoly, it is important to reach as many customers as possible and faster than potential competitors. Skype is an example of a European firm that managed to do this – but few others managed to survive with American competition.
One reason for this is that the market for digital businesses in Europe is still very much fragmented. Digital businesses are exposed to many barriers that prevent them from reaching all 500 million people in the EU. The first barrier is language. A US start-up can reach all 300m US Americans with a website or app only in English. A Chinese start-up can reach many of the 1.3bn Chinese with a Mandarin website and does not face internal barriers. A similar start-up in Europe has to translate its website into many languages which is costly. This is of course a barrier that politics cannot do much about. But there are other barriers that can be lifted: Any US start-up can immediately reach all US citizens within a unified legal space. A comparable EU start-up has to take into account 28 different consumer protection and copyright legislations as well as VAT schedules when selling its products in the entire Union. The legal cost for one firm to serve one additional EU market is estimated to be €9,000 per country, thus a total of €243,000 in order to operate in all other 27 EU member states. This makes it much harder to expand quickly and at low costs, especially for start-ups and SMEs. And thus, it is hard to grow as quick as potential US or Chinese competitors can. In fact, only 7% of European SMEs sell cross-border. The huge potential of the EU of having the largest internal market in the world can only insufficiently be used for EU businesses.
An additional barrier faced by EU start-ups is a much less thriving venture capital environment that in the US. First, the venture capital scene in the US is much larger than the combined EU. But, second, the EU venture capital scene remains fragmented along national borders – not because of legal issues but because of a strong home bias. As a matter of fact 90% of EU venture capital is found in only eight countries: Denmark, Finland, France, Germany, the Netherlands, Spain, Sweden and the UK). This makes it much harder for EU start-ups to find their starting capital.
Finally, the quality of infrastructure used by the digital economy varies largely across the EU. In some areas, fast landline and mobile internet is available, enabling the effective use of the Internet of Things (IoT) along with easy provision of online services. But in many areas of the EU, the fastest way to transfer a large amount of data is by sending a CD via snail mail. Until recently cross-border communication costs could however constitute a barrier for consumers and producers alike – this is an area in which the DSM strategy has already achieved progress, as I shall discuss in greater detail below – by eliminating roaming charges for calls and data usage. Finally, another issue that stands in the way of the development of the digital economy are the sometimes elevated shipping costs from one EU country to another, incentivising domestic consumption. As a matter of fact 62% of the companies that currently do not sell online name this as an impediment.
The consequences of these obstacles are grave: Consumers and companies alike are slow in reaping the potential benefits of a single markets. Only 4% of consumers order products from other EU countries online. Similarly, companies are too slow to make use of the possibilities offered by new technologies. As we showed in a recent study on trade in digital services, most EU countries trade below their potential – and the reluctance of many business but also consumers to use digital tools is one of the main reasons for this weak performance.
What the DSM Strategy set out to achieve
The DSM strategy, first formulated in 2015, set out to address some of these shortcomings and help Europe’s digital economy to grow faster. However, the DSM strategy does not set out to create a single unified European digital space where all rules would be identical and where virtual borders were entirely eliminated. In such a space, there would have be no need any more for nationally different Amazon shops or national iTunes stores. One single website for the entire EU would suffice. While an entirely unified digital space would be desirable as a long term goal, the DSM strategy focussed on alleviating the most harmful barriers first, setting itself a more achievable and realistic task.
The European Commission defines the Single Market as a market “…where individuals and businesses can seamlessly access and exercise online activities under conditions of fair competition, and a high level of consumer and data protection, irrespective of their nationality or place of residence.” In order to achieve this, the DSM strategy builds on three pillars:
- Improved access for consumers and companies to digital services and goods: In this category falls the removal of some disturbing obstacles to digital trade such unjustified geoblocking, but also improving the rules for e-commerce and copyright legislation.
- Better conditions for the development of digital networks and services: Under this pillar falls the creation of fair competition within the telecoms industry and creating the appropriate incentives for the investment in high-speed connections throughout Europe. In particular the distribution of 5G mobile internet is a priority here, as this particularly fast network is a prerequisite for data-intensive applications such as the Internet of Things or autonomous vehicles to operate.
- Better growth potential for the European digital economy: The functioning of the third pillar is to make sure that businesses can make the most of the infrastructure and legal environment put at their disposal. Currently, 41% of European companies do not make use of advanced technologies such as the use of mobile internet, cloud computing or big data analysis. Measure to improve the performance here include a stronger standardisation in order to ensure interoperability, enhance e-government strategies in member states and guarantee the free flow of data within the union, unless constrained by legitimate privacy concerns.
Where the DSM Strategy currently stands
After two years – roughly mid-term – it becomes clear that the DSM strategy has achieved some successes and is broadly in line with its proposed timeline. Probably the biggest achievement is the elimination of roaming charges for phone calls and mobile data usage in the EU. This measure enables citizens of the EU to use their online services in the same way in another EU country as they do at home, with no extra cost. Similarly, a reduction of unjustified geoblocking has also be achieved in the course of the DSM strategy, meaning that EU citizens can now access all resources they legally have access to in their home country in another EU country.
In its own mid-term review, the European Commission is satisfied with the progress it made. 34 commission policy initiatives are adopted, 6 are in the legislative process with Council and parliament and further 6 have yet to be made. Also, most external comments about the mid-term progress are broadly positive, a larger point of concern seems to be that the distribution of 5G is slower than expected. However, no quantitative assessment of the DSM strategy’s implementation has yet been conducted.
Generally, the current DSM is a good starting point as it reduces the most important barriers to the development of the digital sector in Europe. However, there is still a lot of work to do. Eliminating legal barriers is not enough, the degree to which firms in the EU adopt digital will be decisive when it comes to making most of the potential of the industry. The usage of the potential of digital tools to enhance existing industries and service sectors is lagging behind.