The Brussels Effect and its diminishing marginal returns

The Brussels Effect

The Brussels Effect argues that even if the US and China dominate economically and militarily, Brussels simply has to regulate, then several considerations kick in which push international companies wishing to do business in the EU to either apply EU standards themselves, or to lobby their governments to adopt them.

Anu Bradford, who developed the theory, acknowledges it may not last. Her 2019 book closes with factors which could undermine the Effect: Brexit, China’s rise, euro-populism and technological developments.

One is neglected. Brussels has tried to prompt the Effect in many policy areas. But in practice, the number of policy domains is finite, and new, untapped ones can be slow to emerge. This begs the question, when it comes to the Brussels Effect, have policymakers already targeted the easiest, most impactful areas? And, if Brussels has picked all the low hanging fruit, as it seeks to apply the Effect in new areas, will we start to see diminishing marginal returns?

Von der Leyen’s has made clear which sectors are her ‘strategic’ priorities, including biotech, quantum, and space. If the Brussels Effect is Europe’s ‘superpower’ (1) we can assume she will use it to sharpen its edge in these areas. They are interesting case studies.

What makes the Brussels Effect so effective?

Bradford argues that the Effect is most likely to occur when the following criteria are met:

Market size: The EU is a large, rich, single market. Forgoing access because of regulatory costs is an enormous trade-off for companies. Sometimes it is more attractive to comply with laws in order to sell in Europe. As a corollary, the Effect is strongest if a sector exports more to the EU than it imports from it.

Regulatory capacity: Does the EU have the institutions to translate regulation into regulatory influence? Are regulators well-resourced and expertise-driven? Can they impose sanctions to guarantee compliance?

Stringent regulation: Do institutions have the power to implement strict regulation? In Brussels, this tends to derive from a strong legal basis (completing the single market/consumer protection) or public opinion (usually closely tied to the public support for the precautionary principle). Stringent legislation can fill a vacuum when the multilateralism stagnates.

Inelastic targets: How easily can a company sidestep regulation, while still selling to the EU? To sell toys here, one must comply with inelastic product safety legislation, wherever headquartered. Company law is more elastic. To optimise taxes, one might choose to incorporate in a more attractive third country, without losing access to the EU market because of this decision.

Non-divisibility: Once a company adopts EU standards, how difficult is it to tailor products for other markets with different standards as regards:

·      Economics: It doesn’t make economic sense to divide and is just better to apply higher EU standards to all products.

·      Technicality: It is too difficult to divide (e.g. cultivating both GM and non-GM crops is difficult because wind can blow GM pollen, contaminating non-GM crops).

·      Legality: If the cost of having to withdraw from the EU or spin out a business unit to comply with EU competition law is too high, a merger may be abandoned. (*)

What about today’s EU strategic priorities:

The Commission’s agenda is not final. But based on statements and documents, we can expect the following:

Space: An EU Space Law to harmonise fragmented (or non-existent) national space laws, focusing on safety, resilience, and sustainability.

Biotech: An Act building a regulatory environment conducive to innovation in health technology assessment, clinical trials and others (implying a focus on health biotech).

Quantum: An Act to pool resources and create a common framework for increased computational capacity, and a Quantum Chips Plan to strengthen Europe’s ecosystem.

Applying the criteria, we can infer:

Space

Market size: The EU is a net exporter. Today, measured by investment, the EU market is smaller than the US. But, given strategic sensitivities and growing talk of ‘Buy National’ in many regions, market size may become a less of a criterion in establishing a Brussels / Beijing / DC Effect, if governments support domestic firms and penalise foreign ones.

Regulatory capacity: Brussels has experience (Copernicus, Galileo, IRIS²). The Commission Department is well-staffed, but comparatively new, with a hefty brief. Space does not illicit enough attention in Parliament, but Ministers are building ties in Council. The European Space Agency draws on technical expertise and a programming mandate, but lacks regulatory and sanctioning teeth.

Stringent regulation: Only 11 Member States have space laws: a strong  single market rationale. Other jurisdictions have space laws, and multilateral frameworks are fairly weak, with negotiations stalled. The US-led Artemis Accords and Chinese-Russian MoU on the International Lunar Research Station mark a tussle amongst the powers for dominance. There is a case that this creates a multilateral vacuum for EU standards to fill. (I recently heard one MEP referring to it as “the beginning of a WTO for Space”. (2)

Inelastic targets: Remarks by officials suggest the law will apply to all entities operating in the EU. EU market size notwithstanding, supply chains are global and heavily integrated. This implies far-reaching compliance, strengthening the Effect, if access to the EU market is feasible and attractive.

Non-divisibility: EU companies tend to make one thing, well. I suspect contracts are usually low-volume and highly client-tailored, (and lucrative). Technical and economic divisibility are less of an issue, as companies are not trying to flood the market with a standardised, scaled product. Companies have the competence, and incentives (and with emerging tech, increasingly the capacity), to tweak specialised products to client demands. This could diminish the Effect.

Quantum

Market size: The global market is nascent. The EU is strong in R&D and public investment, but has a weaker industrial presence than the US. It depends on China  for components like chips, so is likely a net importer. In theory, this strengthens the Brussels Effect. In practice, escalating export controls and strategic autonomy concerns trump the Brussels Effect and weaken ‘market size’ as a Brussels Effect driver.

Regulatory Capacity: Europe has expertise, but it is concentrated in universities. The more pressing skills gap to fill is in industry – where Europe is seeing a global fight for talent and risk a flight of skills to the more developed US private sector. The Quantum Flagship holds expertise, but was not built to be transformed into a regulatory body. As experience with the Chips Act grows, so too may Europe’s quantum regulatory capacity.

Stringent regulation: Activities in and between EU countries are fragmented, duplicative, or non-existent: a single market coordination rationale. But it can be argued that softer measures than laws are better for achieving that in a nascent, start-up intense sector. The global cooperation landscape is shaped by bilateral agreements. The theory would contend that, down the line, the EU could aim to fill this multilateral vacuum by being the first mover on standards.

Inelastic targets: Presumably a law would be inelastic: benefiting from EU provisions would be contingent on compliance with EU requirements. However, only granting benefits to EU-headquartered companies would undermine the Effect, as foreign companies would have no incentive to try and enter the market and apply EU standards.

Non-divisibility:

As with space (especially in quantum computing, the largest market application) suppliers are highly specialised and products are presumably tailored to client needs. Today, few are sold, but, due to the emerging computational gold rush and potential for future applications, there is a high willingness to pay. Complex, integrated supply chains could make divisibility harder. But the EU is clearly trying to reduce localise. This would have a knock-on impact on the Effect.

Biotech

Market size: Pharma is one of the EU’s biggest exports. From a pricing perspective, the US is probably more attractive. Given demographic and health expenditure dynamics, other parts of the world are also likely to become more appealing. These are not conducive to a strong Brussels Effect.

Regulatory capacity: EMA has a tradition of expertise. The revision of pharmaceutical law aims to future-proof the authorisation process and strengthen sanctions. But there is skepticism if this will lead to better regulation of novel biotech and other, unforeseen innovation. Some HTA bodies worry they lack the resources to implement Brussels-set requirements, but the legislation is still new. The Clinical Trials Regulation aimed to harmonise streamlined processes is also facing regulatory teething problems.

Regulatory Stringency: The Pharmaceutical Legislation, HTA Regulation, and Clinical Trials Regulation use the internal market and public health as legal bases. The latter enjoys particular public support, given pharma law’s origins in the thalidomide scandal.

Other jurisdictions have legislation and standards (but not uniformly updated for biotech). Mutual recognition agreement and forums like ICH shrink the vacuum for more standards for established tech, but there may be scope for novel biotech.

Inelastic target: All three sets of legislation apply to medicines seeking to be authorized and placed on the European market. This market is highly inelastic.

Non-divisibility: I suspect most costs are borne at product development and authorisation stage. Diverging legal, technical and regulatory costs for authorization are probably higher than manufacturing. But the advent of cell and gene therapies – with very different manufacturing procedures –  could change this.

Conclusion

Market size: These strategic sectors tend to be emerging industries, where the EU is sometimes playing catch-up. Many are critical technologies where the EU is considering measures to prevent dependencies. The Brussels Effect is strongest in cases where the EU is already large, established and open to imports.

Regulatory capacity: Varies depending on how long the EU has been legislating. For new iterations of established technologies with existing frameworks (biotech) capacity is likely much stronger than for more wholly novel domains (like quantum).

Regulatory stringency: Completing the single market is the most prominent rationale, especially as these technologies are less directly consumer-facing. The breakdown of multilateralism could create global standard vacuums in the future that the EU could fill.

Inelastic targets: The most clear-cut factor in dictating whether the Brussels Effect applies, but it only works if markets are open.

Non-divisibility: There seems a tipping point where non-divisibility is no longer a problem because manufacturers are so specialised and clients are so willing to pay, that technical and economic costs can be offset by high returns.

These sectors have long, integrated supply chains which may make it more complicated upstream and downstream to comply with EU standards. A shift towards re-shoring and strategic autonomy could reverse that.

Conclusion

Regulation and innovation will always be in conflict. Regulation ensures order, innovation disrupts it. The Brussels Effect ‘worked’ for so long because regulation, not innovation, was arguably deemed the driving factor behind achieving the EU’s strategic objectives.

But, as von der Leyen worries, the world is now “shaped by the fight for a technological edge, by the weaponisation of economic dependencies and by an increasingly thin line between economy and security”.

Europe probably hasn’t picked all the low-hanging fruit. In fact, stagnating multilateralism and emerging tech markets create global vacuums that the Brussels Effect could hypothetically fill. The question is, will doing so alleviate the EU’s new fears?

We will see marginal diminishing return on the Brussels Effect. Not because we have regulated all the sectors that are easily regulated, but because the Brussels Effect was a product of its time. It worked best when the EU saw itself as the “lead beneficiary of, and advocate for, the international order”. Von der Leyen’s quote shows game has changed. So too has EU’s approach. It’s time for von der Leyen to follow her own advice and double-down on sharpening Europe’s technological – not regulatory – edge. (3)

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(1)     Many have discussed if the theory holds and if it is a good thing. I don’t want to add here. I will follow the Brussels consensus and assume that it exists, and that it is good for EU consumers, business, and influence.

(2)     Bradford argues this happened with ETS for Aviation. EU unilateral efforts to regulate global emissions failed, but jump started a process which resulted in progress.

(3)     This is not to say the EU shouldn’t necessarily regulate in these domains. Just that doing so is unlikely to deliver the Brussels Effect, and may in some instances actually blunt our technological edge, much like the AI Act.

(*) Here is how Bradford applied the criteria to a few select policy sectors: