​Designing Innovation-Friendly Regulation 

Designing Innovation-Friendly Regulation

As Europe tries to strengthen its competitiveness in strategic technologies like artificial intelligence (AI) and cloud, the debate over whether regulation constrains innovation has intensified. Some argue that Europe’s regulatory framework raises costs and slows investment; others see regulation as a tool to shape markets, build trust, and support new technologies. Who is right?

This new CERRE paper, produced by Zach Meyers, CERRE Director of Research, and Alexandre de Streel, CERRE Academic Director, argues that this debate needs more nuance. Regulation can support innovation when it addresses genuine market failures, strengthens competition, or helps co-ordinate investment. But European politicians too often ignore the costs of regulation. Poorly designed rules can raise barriers to entry, favour incumbents, and divert resources towards compliance. Regulatory leadership does not automatically translate into industrial leadership: the Brussels Effect has helped European companies compete globally in some cases, but in the digital sector it has fallen flat.

How do we know if regulation has pro-innovation impacts?

A key condition for regulation to stimulate innovation is the existence of a credible pathway towards alternative technologies or business models. Simply making existing activities more costly will not generate innovation if firms have no realistic alternative.

Regulatory design also matters. Regulation that is too weak can impose costs without changing behaviour, while rules that are too stringent can deter investment. This challenge is particularly important in fast-moving digital markets, where overly prescriptive requirements risk locking in existing technologies and limiting experimentation.

Towards smarter regulation

The authors identify three priorities for more innovation-friendly regulation:

• Target genuine market failures: policy makers should clearly identify why innovation is currently suboptimal and how regulation is expected to unlock new investment or business models.
• Combine ambition with flexibility: regulation should set clear objectives while allowing firms flexibility in how they achieve them, supported by proportionate transition periods.
• Improve regulatory institutions: regulators need stronger technical capabilities, incentives to consider innovation, and better dialogue with firms. Guidance should provide genuine safe harbours rather than becoming prescriptive rules through the back door.

The challenge for Europe is therefore not to choose between regulation and deregulation. A more politically viable path is to focus on regulatory design – creating rules that steer firms to behave responsibly, while still incentivising them to experiment and invest in new technologies.