AI Regulation and Its Impact on Innovation: Lessons from Europe

The Adoption of AI and the Threat to Innovation: Lessons from Europe

This Economic Note delves into the complexities surrounding the adoption of artificial intelligence (AI) and its potential implications for innovation, drawing lessons from the European experience.

AI’s Promise and Perils

According to a 2025 international study on artificial intelligence conducted across 21 countries, Canadians recognize the positive impacts of AI on productivity and innovation, yet they also express heightened concerns about its associated risks. Many Canadians favor specific regulations, mirroring sentiments found among European respondents. This raises the question of whether Canada will follow the European Union’s lead with its AI Act.

However, before embarking on this regulatory journey, Canada must consider the complexities and potential negative consequences of such regulations on innovation, the competitive landscape, and international competitiveness. It is crucial to avoid “importing” the mistakes observed in Europe’s approach to AI regulation.

Benefits, but Also New Risks

AI is transforming various sectors including logistics, finance, e-commerce, agriculture, education, and medicine. Its advantages encompass:

Time savings
Improved flow management
Enhanced services

These factors contribute to significant productivity gains, with some estimates predicting an overall productivity increase of 0.53% over a decade and up to 14% for low-skilled support workers due to advancements in large language models (LLMs).

Despite the EU’s regulation aiming to protect health, safety, and fundamental rights, it faces several challenges. The emergence of LLMs like ChatGPT and DeepSeek holds promise for innovation, enabling businesses to perform tasks that were previously cost-prohibitive, thus fostering competition.

Specific Risks of AI

Yet, the deployment of AI brings distinct risks:

Manipulation and Social Control: AI’s use of biometric data poses risks for behavior prediction and social influence.
Autonomy in Accidents: Issues arise from accidents involving autonomous vehicles or diagnostic errors from AI.
Misuse of LLMs: The potential for generating false information or malicious content is concerning.

Legal Uncertainty for Entrepreneurs

Governments are increasingly inclined to regulate AI in response to these risks. The EU’s AI Act, adopted on May 21, 2024, aims to protect citizens from violations of their fundamental rights due to AI systems. However, the regulation may inadvertently hinder innovation and reduce competitiveness without guaranteeing enhanced protection.

Challenges in Quantifying Risk

The regulation imposes obligations on AI suppliers based on the presumed risk level of their products. However, quantifying such risks related to fundamental rights proves problematic, as businesses lack the means to assess the likelihood and severity of potential infringements.

Sector-Based Regulatory Challenges

The AI Act’s rigid sector-based regulation identifies eight sectors as “high risk,” imposing stringent requirements. For large businesses, compliance costs may be manageable, but for startups, these obligations create significant barriers to entry.

For instance, the implementation of a risk management system could cost a single-employee business up to €240,000, while a company with 100 employees might incur costs up to €401,000. This poses a fixed cost that favors established firms over newcomers.

Impact on the AI Ecosystem

The AI Act risks stifling innovation and hindering the development of a competitive AI sector in Europe, which is already lagging behind the United States. In 2024, the U.S. saw nearly three times as many AI startups as Europe, with private investment in AI skyrocketing in the U.S. while stagnating in Europe.