Economic Costs of Ex ante Regulations

Regulations are an indispensable part of an economy and are proven to generate a significant impact on the economic, environment and social landscape. Through an extensive survey of literature and empirical study, the paper contrasts the benefits and costs arising in the light of the imposition of ex ante regulations of attempting to regulate a market sector, before a market failure has even occurred. It diverges from the norm of regulating ex-post, i.e. addressing market failures as they arise, which is the case in most modern open economies.

About this study

The study highlights the economic impacts of shifting from ex post to ex ante in the online services sector as stipulated by the proposals for the Digital Services Act. It estimates a loss of about 85 billion EUR in GDP and 101 billion EUR in lost consumer welfare, due to a reduction in productivity, after accounting for other control variables.

These costs are equivalent to losing all the gains that the EU has achieved to date from all its bilateral free trade agreements; or losing the contribution of passenger cars to the EU trade balance with the rest of the world. In the context of the pandemic-induced economic contraction, the GDP loss is equivalent to one-quarter of EU current account surplus projected for 2020.

The extraordinarily high costs and rarity of ex ante rules warrant a discussion on the true objectives of the Digital Services Act. It is unclear which market failures it is envisaged to address – or how these failures can be so critical for the well-being for the European citizens, yet so irreparable and impossible to remedy ex post.

ECIPE gratefully acknowledges the support for this research paper from Google EU. Authors also thank Sumathi Chakravarthy, Sindhu Bharathi and Adhithya Balasubramanian for their assistance in the econometrical modelling.

Regulations have become an integral part of a society to ensure the effective functioning of markets and the stability of an open market economy. Ideally, economic regulations are designed and implemented to reach their objectives efficiently, i.e. minimise macro or micro level losses.

Regulations, i.e. the imposition of the rules by the government, backed by the use of penalties, modify the economic behaviour of individuals and firms on the market. The rationale for economic regulations arises from the need to curb potential market power, to increase efficiency while ensuring a healthy competition among producers in an economy.

The EU debate often focuses on whether (or how) a market should be regulated. The scope of this study looks primarily to when regulations impact a market – before or after a market failure? Based on the timing of their obligations, they are categorised as ex ante or ex post regulations.

Market regulators are not business strategists, engineers or product developers – in most cases, they are not even economists. They are not better placed to predict what the future of a market holds, who the new market entrants will be, or how they will be entering into a certain market. Therefore, the norm is that regulatory action takes place once a market failure or distortion arises – which is ex post. Until a certain undesirable effect is actually established, consumers and producers are allowed to act accordingly to what they believe maximises their welfare in accordance with well-known and pre-defined set of rules.

In contrast, ex ante regulations broadly aim to identify problems beforehand and shape stakeholder behaviour and responses through regulatory intervention. Ex ante regulations standardise certain practices and policies that solve sector-specific problems by specific predetermined outcomes. In short: Ex ante regimes tell business precisely how to behave, or “what to do” whereas the norm is ex post where regulators tell them “what not to do” by describing the situations the society wants to avoid.

As ex post actions always take place on information available, sufficient evidence is presented to demonstrate the negative externalities and costs with a market failure. In contrast, ex ante takes place on the regulator predicting such events in beforehand and therefore prone to any bias harboured by the regulators. Thus, the approach is also prone to be manipulated by rent-seekers and vested interest groups with preferential political influence rather than by consumer interest.

In conclusion, regulators must put forth precise (and preferably narrow) ex ante regulations that specific problems to avoid unnecessary societal costs. Regulators must also be prepared to continuously re-evaluate ex ante rules to keep up with new market developments, avoid efficiency losses or new types of failures that were not envisaged at the time of legislation. The EU legislative framework is not accustomed to such dynamic and ‘constant’ law-making. In fact, out of date ex ante regulations could cause market failures in themselves.

Ex ante regulations on digital services

Needless to say, ex ante approaches are poorly fitted for sectors that are rapidly evolving or to regulate low-risk general-purpose technologies. A poorly designed and executed ex ante regulation is proven to stifle the innovation outputs in an economy, reducing its ability to catch up with its global competitors. Thus, ex ante is chosen when the externalities and hazards have an extraordinarily high cost of failure – for instance on building code (but only for houses and not for tool sheds), pre-market authorisation of pharmaceuticals or motor vehicles (yet not for food or electric bicycles).

Furthermore, some activities are so sensitive that they are subject to mandatory licensing government oversight – for instance, for healthcare providers and lawyers, but not shopkeepers, marketeers or app coders. What is actually sensitive and thereby under mandatory oversight is clearly culturally and politically contingent. For instance, China is unique in the world to requires online services to apply for an internet content provision license before publishing online.[1]

As part of its Digital Single Market strategy, the EU adopted the Platform-to-Business (P2B) Regulation intended to increase transparency for users, ban unfair practices ex ante albeit narrowly, e.g. unjustified account suspensions.

The EU and the European Commission sees the need for a wider regulatory overhaul. These changes will come through the Digital Services Act (DSA), announced with the proposals in February 2020. The Commission wants the Member States to consider ex ante rules applied to some large platforms to enforce level the playing field between them and smaller businesses and new market entrants. It proposes ex ante requirement for all online platforms, such as rules on self-preferencing of own products for intermediaries and specific obligations on data access, data portability and interoperability.

This study proves that when markets must comply with a predetermined set of operating procedures and standards, they reduce their efforts and investments in innovation. By looking at previous cases of ex ante regulations of a general-purpose technology – notably the telecoms where ex post antitrust requirements were recently coded into ex ante hard law – we estimate the productivity losses for the economy.

We then replicate these results for online platforms as the ex ante regulations from the DSA are of similar scale and effect. They are also similar in approach as EU competition policy rules on abuse of dominant position has been transposed into ex ante requirements whether actual dominance exists. We see that ex ante regulations paralyse innovation landscape, reduce growth and competitiveness, and hamper consumers from reaping potential benefits that arise from a dynamic services industry.

[1] Hindley, Lee-Makiyama, 2009

By: Hosuk Lee-Makiyama Badri Narayanan Gopalakrishnan

Source : ECIPE