Introduction
The European Union (EU) has styled itself a global rule‑setter for digital technologies. The AI Act, adopted in 2024, seeks to classify AI systems by risk and prohibit or restrict uses deemed harmful. Brussels also rolled out the Digital Services Act (DSA), Digital Markets Act (DMA), Data Act, Cyber‑Resilience Act and other instruments as part of its “Brussels effect.” This rights‑driven approach is designed to protect citizens and to project normative power internationally. Regulators argue that high ethical standards and fundamental rights are prerequisites for trustworthy AIcarnegieendowment.org. Yet Europe is also grappling with declining productivity, limited digital champions and underperforming tech sectors. Mario Draghi’s 2024 report on competitiveness warned that Europe’s economic performance is at risk if it does not modernise its digital economy, invest and embrace innovation.
This white paper examines whether regulatory overreach is causing the EU to fall behind in AI and digital innovation. It analyses data on Europe’s AI ecosystem, the complex web of regulation, the knock‑on effects on startups and investors, and structural factors that interact with regulation. It then argues that while ethical safeguards remain vital, the EU must adapt its regulatory model and unlock investment and scale if it is to remain competitive in the AI era.
Europe’s AI and Digital Gap
Lagging investment and model development
- Weak investment and few models: A June 2025 motion by the European Parliament’s Industry, Research and Energy committee warned that “weak investment and too much regulation are causing the EU to fall further behind on AI.” The motion noted that in 2021 the Union accounted for only 7 % of global investment in AI, compared with 40 % for the United States and 32 % for China, and by 2023 Europe invested roughly €5 billion in AI versus $20 billion in the U.Seuroparl.europa.eu. U.S. institutions produced 40 notable AI models in 2024, China 15, and Europe only threeeuroparl.europa.eu. The Stanford AI Index 2025 similarly reported that U.S. private AI investment reached $109 billion in 2024—12 times China’s and 24 times the UK’s—while Europe produced just three major AI models that yearhai.stanford.edu.
- Low AI adoption by businesses: A World Economic Forum survey found that 56 % of large European organisations had not yet scaled AI, and only 13.5 % of EU enterprises were using AI technologiesweforum.org. Another survey of 8,000 IT and business leaders across 26 industries reported that only 18 % of European organisations make AI their top investment priority, compared with 79 % of top global performers; many companies lack robust GPUs and centralised data infrastructureeuronews.com.
- Underfunded startups: European AI start‑ups raised $12.5 billion in 2024, whereas U.S. AI startups raised $81.4 billionintereconomics.eu. Europe captures only 6 % of global AI startup fundingfuncas.es. Limited venture capital, a risk‑averse culture and small home markets mean European start‑ups often move to the United States to scaletheparliamentmagazine.eu.
Digital skills and infrastructure gap
The 2025 State of the Digital Decade report shows that only 55.6 % of Europeans possess basic digital skills and that the rollout of fiber and 5G networks is still laggingdigital-strategy.ec.europa.eu. Many member states remain dependent on non‑EU service providers for government digital infrastructuredigital-strategy.ec.europa.eu. The report identifies fragmented markets and overly complex regulations as persistent challenges and calls for more public and private investment and easier access to venture capitaldigital-strategy.ec.europa.eu.
A Dense Web of Regulations and Growing Complexity
Europe’s digital ecosystem operates under a tangle of roughly 100 tech‑focused laws that span privacy, competition, content moderation, cybersecurity and sector‑specific mandatesecipe.org. The Policy Brief on the Future of European Digital Competitiveness observes that these regulations “restrict Europe’s usage of digital technologies and hinder subsequent productivity growth”ecipe.org. The brief notes that Europe’s ICT sector remains significantly smaller than that of the United States and argues that regulation—alongside insufficient investment—is a key factorecipe.org.
The AI Act and other digital laws
The EU’s AI Act introduced a risk‑based framework to prohibit certain AI uses (e.g., social scoring) and impose strict obligations on “high‑risk” systems. It applies not only to EU firms but to any company offering AI services in Europe, with significant fines for non‑compliance. In November 2025, however, a draft Commission proposal considered granting high‑risk AI providers a one‑year grace period and delaying fines for transparency violations until August 2027fortune.com. The proposal responded to pressure from U.S. officials and large tech firms and recognised that industry needed time to adjust. Critics argued that the AI Act’s definitions were overly broad and its compliance obligations burdensome, potentially stifling innovationfortune.com.
Beyond the AI Act, DMA, DSA, Data Act and Cyber‑Resilience Act impose obligations on gatekeeper platforms, content moderation procedures, data‑sharing rights and cybersecurity standards. Experts warn that the overlapping mandates create administrative burdens and legal uncertainty. A Broadband Breakfast panel highlighted that the DMA’s interoperability requirements have already degraded user experiences—35 % of surveyed EU users found Google search results worse and 60 % said more clicks were neededbroadbandbreakfast.com. Apple delayed releasing Apple Intelligence features in Europe due to DMA compliance issuesbroadbandbreakfast.com.
Fragmented single market and inconsistent implementation
Even when regulations are harmonised at the EU level, implementation varies across member states, creating a fragmented digital single market. Anu Bradford notes that this fragmentation raises compliance costs and complexity for digital companiestheregreview.org. The same study stresses that EU start‑ups rely more on bank loans than venture capital due to underdeveloped capital markets, making risk‑taking more expensivetheregreview.org. Combined with creditor‑friendly bankruptcy laws and a risk‑averse culture, these factors discourage entrepreneurshiptheregreview.org.
Impact on Innovation, Start‑ups and Investment
Barriers within the “single” market
The EU prides itself on its single market, yet barriers remain high. IMF estimates cited by The Parliament Magazine equate these structural obstacles to tariffs of around 44 % for goods and 110 % for services within the EU, compared with much lower barriers between U.S. statestheparliamentmagazine.eu. Entrepreneurs complain that 27 different regulatory and taxation systems make raising capital and scaling across Europe difficult, forcing them to spend time deciphering rules rather than innovatingtheparliamentmagazine.eu. European regulators’ heavy focus on ethics and risk means Europe “regulates first and innovates second”, which slows innovation, pushes startups abroad and leaves Europe trailing the U.S. and Chinatheparliamentmagazine.eu.
Talent drain and limited capital
Europe hosts many world‑class universities and attracts global students, but only 10 % of the world’s top AI researchers choose to live in Europetheparliamentmagazine.eu. 37 % of the EU’s AI specialists are foreign nationalstheparliamentmagazine.eu, yet restrictive visa regimes and limited opportunities cause many to leave after graduationtheparliamentmagazine.eu. The underdeveloped capital markets union means European AI start‑ups receive just 6 % of global AI funding, and without easy access to venture capital, good projects struggle to scalefuncas.es.
Compliance costs and delayed products
The DMA and DSA impose ex‑ante competition rules and content‑moderation duties. Experts from the Cato Institute and ITIF argue that these laws predominantly target American tech firms, imposing significant compliance costs that hamper innovation and degrade consumer experiencesbroadbandbreakfast.com. Some EU users already perceive degraded services due to DMA‑mandated changes in search and app distributionbroadbandbreakfast.com. Apple delayed releasing AI‑driven features for AirPods in Europe because DMA interoperability requirements conflicted with security and privacy designbroadbandbreakfast.com. Such cases illustrate how heavy‑handed rules can delay the deployment of cutting‑edge technology in Europe.
Structural Factors Beyond Regulation
While regulation is a major obstacle, other structural issues contribute to Europe’s lag:
- Underinvestment and fragmented capital markets: The Funcas podcast argues that Europe’s competitiveness problem is fundamentally a productivity problem rooted in underinvestment in information and communication technologiesfuncas.es. European firms struggle to invest in AI and digital infrastructure at scale, partly because risk‑averse banks dominate startup financingfuncas.es. Without a robust capital markets union, scaling across Europe is challengingfuncas.es.
- Risk‑averse culture and slow business churn: The EU’s legal and cultural barriers discourage entrepreneurship. Creditor‑friendly bankruptcy laws make failure costly and deter risk‑takingtheregreview.org. In contrast, U.S. firms fail and restart quickly, fuelling innovationfuncas.es.
- Talent mobility and immigration policy: Europe lacks a unified visa scheme for non‑EU nationals, limiting its ability to attract global talenttheregreview.org. The result is a brain drain to the United States and Chinatheparliamentmagazine.eu.
- Fragmented digital infrastructure: Europe’s digital infrastructure depends partly on non‑EU providers. Only a little more than half of Europeans have basic digital skillsdigital-strategy.ec.europa.eu.
Recognising these issues, Carnegie Europe cautions that the EU’s recent deregulatory shift—intended to boost competitiveness—risks trading away democratic safeguards without addressing structural challenges like underfunding, siloed markets and reliance on non‑EU infrastructurecarnegieendowment.org. The same analysis argues that while regulation is an important geopolitical tool, the real obstacles to Europe’s digital renaissance lie elsewhere, and critics worry that loosening rules without boosting investment will not close the gapcarnegieendowment.org.
Europe’s Shift Toward Competitiveness and Simplification
Growing awareness of these problems has prompted the Commission to reconsider its regulatory approach. In November 2025 the Commission prepared a “simplification package” that aims to reduce administrative burdens by at least 25 % (and 35 % for SMEs) and to delay enforcement of some AI Act requirementsfortune.com. A Commission spokesperson acknowledged that discussions on delaying parts of the AI Act are ongoing but insisted that Brussels remains “fully behind the AI Act and its objectives”fortune.com. Another Commission press release confirmed that the Digital Decade report recommends streamlined regulations, accelerated investment, and improved access to venture capitaldigital-strategy.ec.europa.eu.
These moves signal a recognition that competitiveness and innovation must accompany regulation. However, critics argue that simply pausing implementation does not fix structural issues. The Regulatory Review warns that pauses “do not solve design flaws”; instead, the AI Act needs built‑in adaptation mechanisms to adjust in light of technological changetheregreview.org. Without continuous monitoring and flexible revision, the law risks becoming obsolete or freezing innovation, further widening the gap between European and American firmstheregreview.org.
Balancing Regulation and Innovation: Alternative Views
Scholars caution against reducing the debate to a simple trade‑off between regulation and innovation. Anu Bradford argues that regulations can foster innovation by building consumer trust and legal certainty. She highlights Apple’s privacy‑preserving changes—implemented in response to the General Data Protection Regulation (GDPR)—as examples where regulation spurred innovative designtheregreview.org. Bradford emphasises that the EU’s technological gap also stems from fragmented markets, underdeveloped capital markets, risk‑averse culture and restrictive immigration, not solely from regulationtheregreview.org. She proposes that policymakers focus on completing the digital single market, creating an entrepreneur‑friendly capital market, adopting more immigrant‑friendly visa regimes and building regulatory sandboxes that allow experimentation while protecting rightstheregreview.org.
The Carnegie Europe study echoes this nuanced view, noting that the EU’s deregulatory shift risks eroding democratic oversight and that the real obstacles to innovation include underinvestment and reliance on foreign infrastructurecarnegieendowment.org. It argues for a dynamic third pathway that combines rigorous regulation with aggressive industrial policy, including investment in EuroStack infrastructure and expanded public funding for AI researchcarnegieendowment.org.
Recommendations: Towards a Competitive and Ethical AI Future
To ensure that Europe does not fall further behind in the AI race, this white paper suggests a multifaceted strategy:
- Streamline and adapt regulations: The EU should consolidate overlapping digital laws and align enforcement across member states to reduce complexity. Regulatory frameworks must include adaptive mechanisms, such as real‑time monitoring, regulatory sandboxes and revision triggers, to keep pace with rapid AI advancestheregreview.org.
- Complete the Digital Single Market: Harmonising rules and removing barriers between member states is crucial. The current structure results in effective tariffs of 44 % for goods and 110 % for servicestheparliamentmagazine.eu. Completing the capital markets union would unlock venture capital, making it easier for start‑ups to raise funds and scale.
- Invest in digital infrastructure and skills: The EU needs substantial public and private investment in R&D, 5G/6G networks, computing infrastructure and digital skills training. The ECIPE policy brief recommends accelerating the rollout of 5G (where the EU lags behind the U.S. and China) and boosting R&D to close the productivity gapecipe.org.
- Foster a risk‑taking culture: Reforming bankruptcy laws to be more debtor‑friendly, encouraging venture capital financing and promoting entrepreneurial education would help overcome Europe’s risk‑averse culturetheregreview.org. Regulatory experimentation—through sandboxes—can allow innovators to test new AI systems in a controlled environment.
- Develop a talent strategy: Introduce a unified EU visa for highly skilled AI professionals and invest in programmes that retain graduates. Attracting and retaining top researchers and engineers is essential for a vibrant AI ecosystemtheparliamentmagazine.eu.
- Promote open digital trade: Embrace an open digital trade strategy to secure market access for EU digital services and enable European companies to benefit from global innovation and supply chainsecipe.org. Restrictive data‑localisation requirements and protectionist measures should be avoided unless necessary for genuine security purposes.
- Align industrial policy with regulation: Rather than pitting regulation against innovation, Europe should pair its ethical AI framework with a coherent industrial strategy that invests in AI research, supports scale‑ups and ensures strategic autonomy in critical infrastructurescarnegieendowment.org.
Conclusion
Europe’s ambition to be the world’s digital rule‑maker has produced a far‑reaching body of regulations that enshrine fundamental rights but also create administrative burdens and legal uncertainty. Evidence shows that weak investment, underdeveloped capital markets and fragmented markets exacerbate the continent’s lag in AI and digital technology. While regulations such as the AI Act and DMA aim to protect citizens and ensure trustworthy AI, their complexity and rigidity risk deterring investment, delaying innovation and pushing talent abroad.
This white paper argues that Europe must rebalance its regulatory model: maintain high ethical standards while embracing flexible, adaptive regulation, significant investment, capital‑market integration and scale. By reducing regulatory fragmentation, fostering a risk‑taking culture and building world‑class digital infrastructure, the EU can both protect its citizens and compete in the rapidly evolving AI landscape. The choice is not between regulation and innovation; it is between rigid rules that freeze progress and a dynamic, innovation‑friendly framework that allows Europe to thrive.
Graphic: Europe’s Regulatory Burden
Below is a decorative illustration representing Europe’s heavy regulatory burden on innovation.
