The European bloc was jolted out of its complacency last week after Mario Draghi, the former European Central Bank (ECB) president credited with saving the eurozone in 2012 (“whatever it takes”), published his long-awaited report on how to stop the region’s economic stagnation. It is no secret that the Eurozone’s economic performance has worsened due to competition from Chinese exports, the end of cheap Russian energy, poor labour productivity and American technological dominance.
Mario Draghi has called for a “new industrial strategy for Europe”, asking the European Union (EU) to raise investments by €800 billion a year to fund rapid reform to stop the union falling further behind the US and China.
As well as backing a wholesale overhaul of how the EU raises investment funding, including “new common funding and common assets”, Draghi’s report, commissioned by the EU, calls for Brussels to drive forward a significant reorientation of economic policy.
Key recommendations include relaxing competition rules to enable market consolidation in sectors such as telecoms; integration of capital markets by centralising market supervision; greater use of joint procurement in the defence sector; and a new trade agenda to increase the EU’s economic independence. His demand for more joint debt has already been opposed by Germany, which was expected.
“Never in the past has the scale of our countries appeared so small and inadequate relative to the size of the challenges,” Draghi wrote in the report for EC president Ursula von der Leyen. “The reasons for a unified response have never been so compelling — and in our unity we will find the strength to reform.”
Draghi said, “We have reached the point where, without action, we will have to either compromise our welfare, our environment or our freedom.”
The report comes as the commission prepares for a new 5-year term marked by economic stagnation, a full-scale war on its border and the rise of far-right parties.
The crucial point of the report is that “the EU should aim to move closer to the US example in terms of productivity growth and innovation,” highlighting that no listed European company valued at more than €100 billion has been created in the past 50 years. In America, Apple, Microsoft, Nvidia, Amazon, Alphabet and Meta all surpass $1 trillion.
Europe has experienced weak demand for its exports, especially from China, and its position in advanced technologies like artificial intelligence (AI) is declining. Only four of the world’s top 50 tech companies are European. Nearly a third of European-founded “unicorns,” or companies valued over $1 billion that were founded from 2008 to 2021, have relocated their headquarters abroad, mostly to the US.
The gap in gross domestic product between the European Union’s 27 members and the US, adjusted for inflation, widened to 30% in 2023 from 15% in 2002, mostly driven by lower productivity in Europe. A substantial part of the productivity gap is because some Europeans prefer to work fewer hours, according to a report by McKinsey.
Source: Wall Street Journal
Draghi emphasised the importance of the technology sector, saying it is responsible for almost all the US productivity outperformance over the past 20 years. He argues that “Europe cannot afford to remain stuck” in old industries.
This emphasis on a single sector is a big departure from the post-1980s status quo, which emphasised free markets, entrepreneurship and policies meant to boost the entire European economy – such as educating the labour force and building up infrastructure.
Why the US is more productive is a complex issue, rooted in culture, history, market size, attitudes towards innovation, labour practices, financing incentives, immigration patterns, and many other reasons besides. America remains the largest domestic market in the world, and productive methods that are economical and profitable in America might not be profitable elsewhere. Over time, this leads to the most complex industries flourishing there.
Europe has a gap in non-construction investment rates relative to the US. Its top 3 research spenders in recent times have been car companies. In the US, by contrast, big research and development (R&D) spenders were in automobiles and pharmaceuticals in the 2000s, then in software and hardware in the 2010s, and more recently in digital applications and AI.
Source: Wall Street Journal
It is difficult for European countries to move into these more complex sectors because increasing returns to scale create a natural barrier against entrepreneurial challengers. In the US, Silicon Valley companies, many born in part out of earlier military investments, used network economies to become world champions. Apart from China, countries that have successfully competed against the US in recent decades such as Japan and South Korea have relied heavily on favoured sectors and export markets.
With China now a direct competitor to the US, earlier laissez-faire attitudes are more likely to give way to “industrial policies” that entail tax subsidies and research grants. All this US China competition makes it even more difficult for European countries to effectively compete.
Source: Wall Street Journal
President Biden’s Chips and Science Act and the Inflation Reduction Act granted huge sums of federal money to the domestic semiconductor, electric-vehicle, and clean energy industries. Despite growing pains, they have resulted in a boom in manufacturing construction.
But the EU has failed to react to the same extent, paralysed by fractured political leadership, the sourness caused by Brexit, Germany’s outsized dependence on China and Russia, and an addiction to out-of-date concepts of the “free market”.
The so-called Washington consensus of the late 20th century preached free trade and laissez-faire economic management. Today, targeted protectionism and aggressive subsidies for high-tech sectors is all the fashion.
