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“The main reason why EU productivity deviated from that of the United States in the mid-1990s was Europe’s failure to take advantage of the first digital revolution led by the Internet, both in terms of the generation of new technological firms and the diffusion of digital technology in the economy. Indeed, if we exclude the technological sector, EU productivity growth over the past 20 years would be almost equal to that of the United States.” This passage from Mario Draghi’s report on European competitiveness points to a central part of the agenda for the future of the EU.
Important as it is, this is only one of the strategic economic challenges facing the EU. Others are energy vulnerability, the ecological transition and the rise of protectionism. Draghi offers a framework and suggestions on how to respond to them, including more interventionist trade and industrial policies. The challenge is to make these policies targeted and sensible.
In the defence sector, for example, there seems to be reason to follow the example of Airbus. Compared to the United States, the European defence sector is too fragmented, so cross-border mergers seem essential.
Similar problems exist in banking, capital markets and energy supply. For various reasons, governments refuse to allow much-needed cross-border integration. This largely reflects nationalist politics and special interests. As a result, regulatory barriers persist. Fortunately, the history of the EU shows that such obstacles can be overcome with political will. But will this ever be achieved?
The shift to “clean technologies” in the automotive and energy sectors is a more complex challenge. As Draghi’s report notes: “Due to a rapid pace of innovation, low manufacturing costs and state subsidies four times higher than in other major economies, [China] “The EU is dominating global cleantech exports,” creating opportunities for accelerated adoption of new technologies, but also disruptions for important EU industries and the possibility of being locked out of parts of the supply chain, such as batteries, due to lack of access to critical raw materials. In short, intervention is inevitable. Trade law also allows for it. Intervening effectively is another matter, but, if done carefully, it should be possible.
The digital revolution is another matter. It would be absurd to imagine that investment in “EU champion” versions of Google, Microsoft, Apple or Nvidia would work. Nor would standard trade measures help – how could Google searches be hampered without introducing Chinese-style restrictions? Nor does it seem plausible that there would be no funds available for attractive technological opportunities, although capital market reform should help build a larger venture capital industry in the EU. But the fact that venture capital investment in the EU was barely a fifth of that in the US in 2023 is not due to a shortage of savings in the EU, but to a failure to create the necessary technological ecosystem (see charts).
Why has this happened, then? It is not that the EU is short of staff. Informed analysts argue that it is largely due to over-regulation. There are two types of regulation that are crucial: regulation of the tech sector specifically, and broader regulation of the economy, especially of the labour market, which particularly affects unpredictable startups. If you can’t fire someone, you won’t hire someone, and so someone will be looked for elsewhere.
Well-known technology expert Andrew McAfee from MIT has made a powerful… criticism He agrees that the state of the EU tech industry is pitiful, but the problem is not a lack of money: EU governments spend roughly the same amount (and percentage of GDP) on supporting research and development as the US federal government does. Yes, the former is fragmented across member states, but that is not the main problem, he argues: “It is government intervention in that ecosystem not with funding, but with laws and regulations, and other restrictions and burdens on companies.”
The technology policy analyst Adam Thierer explains the point: “Several recent studies,” he notes, “have documented the costs associated with the GDPR. [General Data Protection Regulation] and, more generally, the EU’s heavy-handedness regarding data flows.” This imposes high costs on innovative companies and, inevitably, the smaller the company, the higher the implicit tax. Given this, as well as the EU’s fragmented markets, it is no wonder that the US is so far ahead.
An article by Oliver Coste and Yann CoatanlemThe paper, published by Bocconi University in Milan, raises another important and even broader point about regulation: new, dynamic firms need to be able to adjust their costs quickly in light of market developments. Thus, the authors note, restructuring costs, largely the result of employment protection regulation, are critical. The more expensive the restructuring, the more cautious the firm. Cumulatively, these protections are crippling. The UK Labour Government They should take this potential danger into account in their plans.
Draghi agrees that regulation is an important issue. Thus, he notes, “the EU’s extensive and strict regulatory framework (exemplified by policies based on the precautionary principle) can, as a side effect, restrict innovation. EU companies face higher restructuring costs compared to their US peers, putting them at a huge disadvantage in highly innovative sectors characterised by a winner-takes-most dynamic.” He even recommends a new “Commission vice-president for simplification.” Good luck with that approach.
The question is more philosophical and political. The EU needs to find a way to regulate the technology sector that does not at the same time hinder its growth. Doing so will be a huge challenge.